The Surprising Retirement Planning Mistake that Starts at the SSA

Just give us your best guess.

Most financial advisors let the software do the heavy lifting when it comes to stress-testing a client’s retirement income plan with modern tools that can quickly run Monte Carlo simulations to address longevity risks. Useful as they are, though, a common problem has become inputting inaccurate Social Security benefit projections sourced from the Social Security Administration itself. As the agency has admitted, its estimates often cause individuals to either over or underestimate their future benefits, especially younger workers and women. It’s a problem that advisors will have to address in order to build successful retirement plans.

“We’ve looked into the issue and we do see many traditional planning models struggling with this,” said Sharon Carson, retirement strategist at J.P. Morgan Asset Management, adding that advisors usually overshoot on the benefit estimate. “It’s a problem when people end up with less income than they were expecting.”

Don’t Get Overzealous

If a client is currently earning $150,000 a year, the SSA calculates their primary insurance amount as if they’ll work for the same wage until retirement, plus a small annual inflation adjustment. In reality, they might not work that long or at wages that high. 

“Most software either uses your most current salary as the starting point to back into an estimated Social Security benefit, or it asks someone to put in their primary insurance amount from their most recent statement,” said Marcia Mantell, a Social Security expert and founder of Mantell Retirement Consulting. “If you aren’t really close to your full retirement age, the numbers can get skewed and become overzealous.” Mantell’s other chief concern is that income planning tools aren’t inflating Medicare Part B premiums aggressively enough. “Best practice today is to project 8% to 10% Part B annual increases,” she warned.

The latest Chase consumer banking data shows American households earning $300,000 replace just 55% of their pre-retirement income on average after retirement, with 41% coming from private sources like 401(k) plans and 14% coming from Social Security. It sounds like a dramatic cutback, but a 45% reduction in annual income is not as big a lifestyle change as one might assume. “You have to keep in mind that these people are entering a stage of life where they’ve already paid off their mortgages, they’ve finished paying for their children’s college, they’re not commuting to work,” Carson said. “They don’t need to spend as much.”

People who are lower on the income spectrum may replace more of their income in retirement, but that doesn’t mean they’re better off. Take, for example, the average household with $100,000 in pre-retirement income:

• They replace 76% of their working income, with 33% of the money coming from Social Security checks. 
• The replacement rate is higher, but their $76,000 in retirement income is lower in absolute terms compared with the wealthiest cohorts. 

“A household at the $40,000 level replaces 95% of income, with more than half of that coming from Social Security, but you obviously wouldn’t say they are better off,” Carson said. 

Are Cuts Coming? Many clients (and some advisors) believe Social Security’s shaky financial position makes benefit cuts inevitable, so they do things like claim early to get their hands on the money while they still can. “We think this is the wrong perspective,” Carson said. “Reforms aren’t easy to accomplish, but the political power of seniors is undeniable. It’s politically untenable to think that members of Congress would simply do nothing and let Social Security cuts happen.”