How I’m Thinking About Social Security and FIRE
Over the past few weeks, we’ve taken a look at the Social Security program’s future funding problems, as well as a number of potential solutions that could close the coming funding gap.
Today we’re going to get more personal, and discuss how I’m thinking about Social Security as we continue down our path towards financial independence and early retirement.
I’ve written in the past that I haven’t factored any potential Social Security benefits into the framework I’ve developed to measure our progress during our quest for financial independence and early retirement.
But I’ve also mentioned I do expect to eventually receive something from the Social Security program when I am old enough to claim retirement benefits.
So how do I explain this seeming contradiction?
I’m not counting on any Social Security in the calculations I’ve made around potential early retirement in the interest of conservatism. I think my assumptions are pretty good and reasonably conservative. But not factoring in any Social Security benefits will give our family an extra cushion when we are older if we receive benefits in the future.
Moreover, Mrs. ROMT and I are still both over 15 years away from being eligible for any Social Security retirement benefits, and more than two decades away from our full retirement age. While it will be great if we receive something in the future, we know for a fact we won’t be eligible to receive any Social Security retirement benefits for well over a decade after we reach early retirement and financial independence. So it doesn’t make sense to me to count on those potential benefits at all when I’m contemplating the cash flows we’ll need for expenses when we first retire.
That said, despite the pressure the Social Security system is likely to be under during the next decade and a half as demographic changes deplete its $2.9 trillion surplus, I think we’ll eventually receive some benefits from the program. The Social Security Board of Trustees currently believes that continuing income to the combined trust funds from workers via payroll taxes will be sufficient to pay 79% of scheduled benefits when the surplus is depleted in 2034. The Old-Age and Survivors Insurance (OASI) program, which is what pays Social Security retirement benefits, is expected to be able to pay 77% of scheduled benefits at that time.
That figure could be higher if American politicians make some changes to improve Social Security’s finances in the next few years, but it could be worse if legislators continue to kick the can down the road and avoid making necessary changes to the program.
Regardless of what happens in the coming years, I’m not expecting to receive the exact amount that currently appears on the front page of my annual Social Security Statement (you can sign up for your statement at the Social Security Administration website).
By the time I reach retirement age, the Social Security trust funds will not have the assets to pay the full benefit outlined on my Social Security Statement unless significant changes are made to the program’s finances. Moreover, that prospective benefit assumes I’ll keep earning roughly the same amount as I am today each year until I finally decide to collect Social Security. As someone who’s contemplating early retirement in the next few years, my payroll earnings are likely to be lower in my 50s and 60s than they have been for most of my 30s and 40s.
Potential Social Security retirement benefits are currently determined by complicated formulas that consider the amount of earnings you had that were subject to Social Security taxes each year, the number of years of earnings you have accumulated, whether you worked enough years and earned enough money each year to qualify for Social Security “credits”, and other factors. If you want to know all the details, you should visit the Social Security Administration website.
Right now, benefits are calculated based on the 35 years during which you earned the most. Something potential early retirees need to consider is that if you don’t have at least 35 years in which you paid into the Social Security system via payroll taxes, the current benefits formula will give you credit for earning $0 in as many years as you need to get to 35 years of earnings.
For example, if someone only paid into the Social Security system for 15 years, their earnings over those 15 years will go into the calculation of their potential benefits – along with $0 in earnings for the other 20 years. This will reduce potential Social Security retirement benefits for those who are retiring very early significantly.
Right now, there are 31 years (1988-2018) during which I have earned money that was taxed by the Social Security system. If I am actually able to reach financial independence and retire early in 2021, I’ll have amassed 34 years with Social Security earnings, meaning I’ll only have one year with $0 going into the calculation of my benefits.
Of course, the rules can, and likely will, change by the time I am eligible to receive retirement benefits. There have been proposals to base benefits on 38 years of earnings, which, if enacted, would likely cut future benefits further for myself and other potential early retirees.
I should also note that I earned relatively little while in high school and college, so I have a number of years with low (but at least not $0) Social Security earnings that currently factor into the calculation of my potential benefits. That means the longer I continue to work, the larger my potential benefits could be.
If I work for a year past my Target FIRE Date into 2022, I’ll have 35 years with some earnings. If I work into 2023, I’ll be up to 36 years with Social Security earnings, which would kick the lowest-earning year of my career, 1988, out of my top 35 years, and also give me an extra year of paying into the system in case the benefits formula changes in the future to consider earnings from more than 35 years. Working into 2024 would similarly kick my relatively weak earnings year of 1992 out of the benefit calculation and give me a 37th year with taxable Social Security income. Thinking strictly about maximizing my potential Social Security retirement benefits, there is likely always going to be a reason for me to consider working for “just one more year”.
Fortunately, given the way benefits are currently calculated, and the amounts I have earned during each year of my career, the marginal benefit of another year of work on my future retirement benefits is relatively small. Using some of the online calculators available at the Social Security Administration website, I estimate that if I stopped working today, my potential Social Security benefit at my current full retirement age of 67 would still be nearly 80% of what I could receive if I continued earning what I do today for another 20+ years until full retirement age.
So even though my future Social Security benefits will likely be higher the longer I do work, it’s good to know I’ve already done most of the heavy lifting to receive benefits. And working for the next three years will knock three more $0 years out of any future calculations, which should boost any benefits I eventually receive.
The Social Security Administration warns on my annual Social Security Statement that “Social Security benefits are not intended to be your only source of income when you retire. On average, Social Security will replace about 40% of your annual pre-retirement earnings. You will need other savings, investments, pensions, or retirement accounts to make sure you have enough money to live comfortably when you retire.”
Fortunately, I’m not relying on receiving anything from Social Security when I run the numbers on how much we’ll need to save for early retirement. I do expect I’ll receive something in the future, but anything I receive will be a bonus that should make our potential retirement lifestyle a bit better, and increase the likelihood we’ll eventually leave something for our children.
After reviewing our personal financial situation, the 2018 Annual Report from the Social Security Trustees, my Social Security Statement, and some of the online calculators available on the Social Security website and from the Committee for a Responsible Federal Budget, I put together several scenarios trying to project how my Social Security benefits might look when I reach my full retirement age of 67:
In most cases, I expect to receive some Social Security retirement benefits once I am eligible. The worst case scenario, of course, is that I receive no Social Security benefits despite paying into the system for decades. Even given current dysfunction in our government and troubling demographic trends that are likely to deplete Social Security’s surplus over the next decade and a half, I think it’s unlikely my family and I will receive nothing after paying into the system for roughly 35 years, and estimate the probability of the worst case scenario at just 10%.
But, given my conservative nature, I’m still not factoring any potential benefits into my early retirement calculations. I’m continuing to view Social Security retirement benefits as a supplemental insurance policy that we are not depending on, but could provide a nice boost to our financial position in a couple of decades.
How are you factoring potential Social Security benefits into your financial independence and early retirement plans? Do you think my scenario probabilities are optimistic, pessimistic, or about right?