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Family Finance: Social Security affects retirement

Lynn Brenner | Family Finance

July 20, 2008

Your June 15 column was the first time I've ever seen a formula for figuring out how much you need to save for retirement that makes sense. Does it take Social Security into consideration?

D.R., via e-mail

The amount of retirement income you need your nest egg to produce for you every year is reduced by your Social Security benefit.

Let's say you decide you'll need $65,000 of inflation-adjusted annual income in retirement. In other words, you want that $65,000 to maintain its purchasing power. Before figuring out what you need to save, check how much of that $65,000 a year you can expect from Social Security.

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The government has made this easy: Everyone over age 25 receives an annual statement that gives a dollar estimate of their future Social Security benefit. Of course, this estimate is based on your current salary and on current law, and both are likely to change. But the yearly statement reflects these changes, so it's a very useful financial planning tool.

You'll see the monthly retirement benefit you can expect if you start collecting it at age 62; at your full retirement age, which depends on your birth date; and at age 70. (Full retirement age is 66 if you were born between 1943 and 1954; it gradually rises to 67 for people born in 1960 or later.)

If you start taking your benefit before you reach your full retirement age, your monthly checks will always be smaller than if you had waited. If your full retirement age is 66, for example, taking your benefit at 62 results in a permanent 25 percent cut in your monthly check. For anyone with an average or longer-than-average life expectancy, that's a very expensive choice. On the other hand, if you postpone taking it until age 70, your monthly check will be up to 8 percent bigger than if you take it at full retirement age. (To figure out when to take your benefit, use the 'break-even age' calculator at ssa.gov).

OK, so let's say your projected Social Security benefit is $25,000 a year. If you want $65,000 a year, you only need to get $40,000 a year from your savings. How much do you need to save to produce a constant $40,000 a year for a 30-year retirement? For the answer, take the percentage of your current salary that you want to replace, and divide it by four. Let's say you currently earn $100,000 a year. You want $40,000 a year from your savings in retirement, or 40 percent of your salary. Divide 40 percent by four. The answer is 10. At retirement, you need a nest egg that is 10 times your current salary - in other words, $1 million. (If that goal is out of reach, consider a smaller annual retirement income, or a later retirement, or working part time in retirement to supplement your savings, or all three.)

A million dollars sounds like a huge sum to produce just $40,000 a year. But remember, you want that $40,000 to be inflation- adjusted. In other words, if the cost of living rises 3 percent during your first year of retirement, in the second year you want to tap your savings for $41,200, $40,000 plus 3 percent for inflation. (Your Social Security benefit includes an automatic annual cost-of-living increase.)

For a sobering look at how inflation cuts the value of a dollar over time, check out the government's CPI inflation calculator at data.bls.gov/

cgi-bin/cpicalc.pl. This calculator reflects annual changes in the prices of all goods and services since 1913. In the past eight years alone, the increase has been dramatic. In 2008, it takes $81,771.66 to buy goods and services that cost $65,000 in 2000.

Send questions to Family Finance, Business Desk, Newsday, 235 Pinelawn Rd., Melville, NY 11747-4250, or e-mail to Bfamfin@aol.com. Include your age, income and a list of major assets. Letters and e-mails can't be answered personally.