How Much Income Does Social Security Replace?

School of Social Security & Medicare

Social security benefits statement being reviewed by a retiree

When planning for retirement, people regularly overestimate the amount of their income that Social Security will replace. This often leads to an ineffective financial plan and an underfunded retirement. To ensure you don’t end up in this situation, it’s critical to understand how much of your income Social Security is expected to replace. Then you can take steps to ensure your retirement plan can keep you comfortable throughout your golden years.

To learn even more about the transition from working to retirement, sign up to attend our no-cost webinar, Defense Wins Retirement: How to Shift Your Strategy from Growth to Income, hosted by the President of our company, Kyle Whittington, on August 23rd at 3:00pm central time.

Workers Often Overestimate Future Social Security Benefits

A 2019 study showed that workers saving for retirement anticipated monthly Social Security benefits of $1,805. However, current retirees received an average of $1,408 per month in Social Security benefits – a 28% difference in expectations and reality. This disconnect can lead unprepared retirees directly into financial turmoil.

The same study also showed that 26% of older adults believe they can retire comfortably on Social Security alone. Once again, this expectation is thwarted by reality. In most cases, Social Security falls quite short of providing a comfortable retirement.

How much of your retirement income comes from Social Security?

The amount of retirement income that comes from Social Security benefits can vary widely between individuals. In general, those who earned higher salaries during their working years should expect more Social Security income than those with more meager salaries, but there are some caveats.

Social Security retirement benefits are calculated based on a formula that uses inflation adjusted average earnings for a worker’s top 35 years. The amount of income that can be included in this formula decreases as income rises above certain bend points. This means a worker with a high preretirement income may see a smaller percentage of their preretirement income replaced by Social Security. In addition, Social Security benefits are capped. In 2022, the maximum monthly Social Security retirement benefit for someone who retires at their Full Retirement Age [FRA] is $3,345.

The average worker who earned $50k per year prior to retirement will receive about $17,500 a year from Social Security, which equates to about 35% of their preretirement income. Moreover, a worker who earned $300k per year before retirement will receive about $32,000, or only 11% of their preretirement income, in the form of Social Security.

Is Social Security enough to maintain your lifestyle in retirement?

The amount of income you will need in retirement varies based on your lifestyle and expenses. However, most don’t need to replace 100% of their preretirement income because expenses are typically lower in retirement. For example, retirees typically don’t add to retirement plans, they generally have a lower need for some types of life insurance, and they often have reduced expenses for things like clothing and transportation. In addition, some retirees choose to pay off debt, like a mortgage, before retiring which further reduces expenses.

For most people, Social Security benefits are not enough to cover their retirement expenses. According to research from Fidelity, investors typically need to replace between 55% and 80% of their preretirement income to maintain their lifestyle. As shown previously, Social Security benefits typically replace between 11% and 35% of income. This creates an “income gap” between Social Security benefits and the amount of income needed to fund your lifestyle. Most workers rely on their investment income to close this gap.

Funding Your Retirement Above and Beyond Social Security

The average worker’s savings will need to generate about 45% of their preretirement income each year to fund their lifestyle. To illustrate how most workers fund their retirement, consider the following chart.

Source: Fidelity. This information also appears in our upcoming Defense Wins Retirement webinar. To learn more, register for this live webinar that will take place August 23, 2022.

According to this data – the average worker who earned $50k per year before retirement will need to replace 80% of their income to maintain their lifestyle in retirement. In this scenario, Social Security replaces 35% of their preretirement income. Therefore, this worker needs their savings to generate 45% of their preretirement income to fund their lifestyle.

Now consider a worker with a larger salary. A worker who earned $300k per year will likely need to replace a smaller 55% of their income to maintain their lifestyle in retirement. This worker will receive just 11% of their preretirement income from Social Security but will need their savings to account for 44% – almost the same percentage as the lower salaried worker.

The amount of income your savings need to generate to meet your retirement goals is called your Required Rate of Return [RRoR™]. This figure is the key to a successful retirement plan because it determines the amount of investment income your portfolio needs to generate to cover your expenses without the need to access your principal. Your RRoR™ is a critical component of your financial plan and it is the cornerstone of your Financial Fingerprint™.

Get Answers to All Your Social Security and Retirement Questions with Meld Financial

When you have questions about your Social Security benefits or your retirement income sources, turn to the team of tax, legal, and investment professionals at Meld Financial. Throughout more than 40 years of managing our clients’ wealth, the team at Meld Financial created Financial Fingerprint™ – a comprehensive wealth management plan that is quick to assemble, easy to understand, and simple to modify as your circumstances change.

This plan will help you quantify your income sources during retirement – like Social Security. In addition, Financial Fingerprint™ can help you determine how much you need to save, calculate your RRoR™, and craft a withdrawal strategy designed to ensure your income lasts a lifetime. To learn more or get started today, contact us.

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