Yes, You Might Be Saving Too Much For Retirement

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You might be saving too much for retirement, if you aren't factoring in Social Security. But Social Security is the subject of a lot of pessimism, with many claiming "It'll run out by 2035!" The problem with this sentiment? It’s actually misleading.

So what are the implications for your future, and more importantly, your financial independence number? We'll dive into the future of Social Security, how it works, and whether you’d be better off taking home those wages and investing them yourself—and you'll probably leave you feeling really good about your own progress. 

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Our show is a production of Morning Brew and is produced by Henah Velez and Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is our Chief Content Officer and additional fact checking comes from Kate Brandt.

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Transcript

Transcript

Katie:

Okay, before we get started today, it feels important to state upfront that a lot of what we're going to talk about in this episode might seem counterintuitive in contrast with the general tenor of financial reporting, because the state of retirement in general in the US is, by some experts’ estimations, in a state of crisis.

That said, the audience of a show like this one, the 150,000 of you who listen every month (hashtag tell your friends, share the show baby), y'all are people who probably are saving for retirement. If you know about financial independence and you are actively calculating and working toward it as a goal, you are already meaningfully ahead of the pack and that is the intended recipient of this message.

So while I wouldn't play this episode probably for your average American with a 4% savings rate and go, yeah, hey, you're saving too much, stop worrying. I know that many of you are saving and you might have been doing so for a long time or are intentionally working on saving more, or at the very least you're taking pains to improve your situation in some other way. So even if you are in a season of your life right now where it isn't yet feasible to save money, I know that you will be soon.

So that disclaimer out of the way, welcome back to The Money with Katie Show, my Rich People, Rich People Nation. As always, I'm your host Katie Gatti Tassin, and today we're talking about why you might be saving too much for retirement. How much? Probably to the tune of like 30%, but we're getting ahead of ourselves.

The pyramid shaped elephant in the room is none other than Social Security. So we'll also be discussing the state of that government program and whether or not the fearmongering that claims it's going to run out is legitimate and how it applies to your future.

So the financial planning rule of thumb, it says that most people will need between 70 and 80% of their pre-retirement income to live comfortably, which is a directive that kind of immediately makes me question why we waste so much time debating the age-old Traditional versus Roth question about whether your tax rate is going to be higher or lower in retirement. But I digress. Still, there are some underlying assumptions here that deserve a little more attention. Does this assume that your average person is saving between 20% and 30% of their pre-retirement income? It almost definitely takes into account that you're not going to be paying the 7.65% payroll or 15.3% self-employment tax anymore in retirement.

But the math that delivers us to this calculation isn't totally clear to me, particularly as an adherent to 4% rule methodology that what you need in retirement has more to do with how you spend before retiring, not how much you're earning.

But for the sake of argument, let's assume it's true that regardless of how we land there, this 70 to 80% of pre-retirement income guideline is a good one. The next question becomes how are you going to provide that to yourself?

Since Social Security is the backbone of this episode's hypothesis, let's begin with a brief history, shall we? And for our non-US listeners, my apologies, but my hope is that your country also has some sort of state funded pension program that implies the same outcome that we're going to be exploring today.

So the Social Security program in the US is nearly 90 years old and when President Franklin Delano Roosevelt signed the Social Security Act into law in 1935, he was called a socialist. That is until those checks started hitting mailboxes and then critics were like, actually, this rocks.

Clip:

“Because it has become increasingly difficult for individuals to build their own security, single-handed government must now step in and help them lay the foundation. Stones just as government in the past has helped lay the foundation of business and industry, we must face the fact that in this country we have a rich man security and a poor man security and that the government owes equal obligations to both. But national security is not a half and half measure. It is all or none.”

Katie:

But the original quote unquote formula in which Social Security was supposed to be just one leg of a three-legged stool along with a pension and personal savings has shifted radically over the last few decades. It's only intended and was only ever intended to cover roughly 40% of your retirement income, though AARP reports that 12% of men and 15% of women rely on it for 90% or more of their income in retirement. The hardest hit recipient is the widow who has outlived her family savings and is now living into old age on just seven or $800 a month. Still, it's hard to overstate how important this program is. Without it, it's estimated 22.7 million more Americans would live below the poverty line. That's why it's so frightening to read headlines that declare Social Security is going to run out by 2033 or 2035 depending on which click-hungry financial media source you're consulting on the matter.

Because while it's true that the latest annual report estimates that we'll be running out of money in about 11 years, this framing is a little misleading. As a result, 45% of Gen Zers don't expect to see a penny of Social Security money in old age, but experts say that people frequently misunderstand what's meant by the claim that the trust will run dry in 2035. That is a key concept in our understanding, the trust, and in order to make sense of how it gets funded and why it might be running out, we have to talk about how it's designed to work right after a quick break.

So how is Social Security funded? You pay into Social Security with every paycheck you receive and if you're self-employed, you cover both the employee and the employer or portion of your obligation because you're a bad gal like that. And you might see it written simply as FICA on your paycheck, which is inclusive of Medicare as well. Or you might see it broken out as Social Security or SSDI, which stands for Social Security Disability Insurance, but whatever you call it, if you're a wage worker in the US, you are paying it.

How much are you paying? 6.2% of your wages on up to $168,600 of income in 2024. Though this might be slightly understating it because your employer is also paying 6.2% on your behalf, which is money that ostensibly would've otherwise gone to wages. So if you're self-employed and you earn up to the limit of $168,600, that means that you are responsible for putting about $21,000 into the Social Security coffers each year.

The money that you're paying in now is also paid out now to people who have already retired, or people with qualifying disabilities, survivors of workers who have died, and dependents of beneficiaries. And this by the way, is a common misconception that they're just putting the money away into some government account with your name on it for your retirement.

No, as you work and you pay taxes, you earn Social Security credits and as of 2024, you earn one credit for each $1,730 you earn. So $1,730 per year up to a maximum of four credits per year. Most people need 40 credits total or 10 years of work to be eligible for benefits. And this means not working or going years with very low earnings might make your benefit a lot lower than if you had worked steadily, which is a fact that has implications for both stay-at-home parents and very early retirees.

So why does it matter that the money being paid in now is also being paid out now because in 1955 there were more than eight workers supporting each and every Social Security beneficiary. That is to say, for every person who was getting that Social Security check in the mail, there were eight people that were working and paying into the system. Today there are only 2.8 workers per beneficiary, and by 2035 it's estimated there will only be 2.3 due to declining birth rates. And I know what you're thinking. Wait, is this a pyramid scheme? Yeah, kind of.

But income inequality also plays a role. The wages above the payroll tax limit have grown much faster than wages at the bottom of the distribution. So much of the income growth in our economy has happened outside the bounds of the upper limit of income that are eligible to be taxed for Social Security. So put another way, someone who earns $300,000 per year only pays 6.2% on that first $168,000 of earnings that remaining $132,000 is not taxed at all for Social Security.

The funds in the trust peaked at almost $3 trillion in 2021 and estimates expect it to run dry by 2035 if nothing else changes, which is 23 years earlier than when they expected. Why is this the case? Because we are currently paying out more in benefits than we are taking in revenues.

So we basically have to tap our emergency fund, which is the Social Security Trust. That's what people are referring to when they say it's going to run out in 11 years. Not that it won't exist anymore, but that the surplus that we have saved from the years when we were taking in more than we were paying out will be gone functionally. This means we're still going to be able to pay out benefits that are coming in via new tax revenues, but we won't be able to make up the difference with our Social Security Trust fund.

Savings experts estimate that incoming funds that is our tax revenues from everyone's paycheck contributions will be enough to cover 83% of Social Security's expense obligations and conservatively, some experts think this means we are going to be able to pay at least three quarters of the promised benefits through the year 2100 meaning Gen Z needn't worry, but Gen Alpha might need to.

I created an account at ssa.gov under “get a benefits estimate” and learn that I have 35 of the 40 work credits that I need to receive my benefits. So since I don't have all 40 credits yet, I don't think it's going to show me an estimate for my future benefits. At least I haven't been able to find them anywhere. But I did learn that I have paid $42,869 in Social Security benefits and $26,295 in Medicare taxes so far. So that's fun. The obvious next question then becomes, well how are they going to calculate what they pay me?

So how Social Security gets paid out, it's estimated that 180 million Americans worked and paid into Social Security in 2023 and 67 million people received the monthly benefit. So if you were born in the year 1960 or later full retirement age for you is 67, you can start collecting Social Security checks as early as age 62, but they're going to reduce your benefit. If you start before age 67 your benefit increases by 0.5% on average for each month in which you receive benefits before that retirement age. So for example, if your full retirement age is 67 but you start at age 62, you'll receive 70% of what would be your full benefit. There are specific rules about divorce, disability, death, all of that stuff that we're going to link in the show notes because they're honestly too boring to recount here…she says in an episode about checks, notes, Social Security. But NerdWallet has a cool estimation calculator that'll help you determine the breakeven point for deciding when you want to start taking your benefit in order to maximize it.

As we stated at the opening of the show, this program was never meant to be your sole source of income in retirement and the maximum amounts that you can receive reflect that. According to NerdWallet, in 2023, the average benefit for retired workers was $1,843 per month. I wanted to play around with their calculators to get a sense of scale for average and high incomes today. And I noticed that different calculators online were spitting out radically different results. It took me a lot longer than I would like to admit to realize that it's because some of them, like the NerdWallet calculator, were adjusting for inflation and showing you what your benefit would be worth in today's dollars, which is helpful if you're a 25-year-old spring chicken with 40 years to go, while others were showing the actual benefit in future dollars inflated dollars, which makes it look more inflated than like a botched boob job.

Regardless, as I learned while trolling Subreddits of people who were making the same mistake, make sure that you adjust for inflation or pick a calculator that's going to adjust for inflation. So using the official ssa.gov calculator, a worker born in 1994 with an $80,000 annual income who begins drawing down their benefits at age 67 will receive an estimated $33,768 in annual benefits and $41,868 if they wait until they're 70. I was curious to see how an income that's twice as high might impact these numbers. So I entered $168,600, the maximum on which Social Security is paid and the age 67 benefit jumped to $41,232 annually an increase of about $7,000 and the age 70 benefit climbed to $52,416, which was about $11,000 higher per year. So there you have it, sense of scale earning $80,000 today will score you about $34,000 in today's purchasing power at full retirement age while earning more than double, that will earn you about $41,000.

Part of this disproportionality is due to the aforementioned maximum monthly benefits which represent the highest amount that an individual can receive. So if you retire at age 62, your maximum monthly benefit in the year 2024 is $2,710 per month or about $32,520 per year. And at 67 this goes up to $3,911 per month by age 70, around $4,873 per month, which I feel like is a lot of money frankly.

But in order to receive that maximum benefit you would have to earn the maximum taxable wage for at least 35 years thanks to inflation. These are cost of living adjusted every October. And given what we know about future estimates ranging between 75% and 83% of the current benefits, the most realistic way to plan is probably to look at these estimated benefits and assume that you're going to see about 75% of it.

So using the current maximums, we can probably guess that the maximum benefit after 2035 will be in today's purchasing power around $2,200 a month at 62, $2,900 at 65, $3100 at 67, and around $3,900 at 70.

And that is of course assuming nothing changes. There are a lot of ways that we could fix this issue from reducing the cost of living adjustments and raising the income limit to increasing the retirement age. We're not going to spend much time on the ways this might get solved. For the purposes of today's episode, since I want to keep this one more grounded in the tactical, but all hope is not lost, there are a lot of levers Congress could pull to make the tweaks necessary. And if you're someone who's worried about getting your Social Security benefits, you've got one major thing going for you and that's that cutting this benefit would be extremely politically unpopular. I don't really currently see a future in which any politician would do away with it. So we'll get right back to it after a quick break.

Alright, so let's make sense of the implications here for those retiring after 2035. That is a range of between $26,400 per year and $46,776 per year in today's dollars at a maximum depending on your age when you retire and if you earned up to the maximum threshold for 35 years, the entirety of your career, depending on your point of view, that's either a big help or not a great ROI on your contribution of 6.2% of your income each year.

To put it in perspective with our typical financial save withdrawal rate of 4% parlance that range in payments in today's dollars is a little like having an investment portfolio worth between $800,000 and $1.4 million if things are funded at a hundred percent and between $660,000 and $1.2 million if they're paid out at 80%. Because in order to provide yourself with between $26,000-$46,000 a year in income, you would need an investment portfolio worth 25 times those numbers respectively.

I wanted to run a little counterfactual and see what would've happened if you would've taken home that 6.2% instead of paying into Social Security and invested it instead for an average 7% annualized return, assuming that you are working for 30 years and you're earning that maximum Social Security eligible income of $168,000, you would end up with a portfolio worth $995,075. This is assuming that you are investing about $10,000 a year. So if funded at a hundred percent, the Social Security payment after age 65 is actually preferable to independent investment if you are following a 4% saved withdrawal rate. But if it's only funded at roughly 80% as we expect to see, it's only preferable if you are withdrawing after age 70. So I'm going to say that again because I do think that you often hear, I'd rather take that money home with me and just invest it myself, which is an inclination that I understand though that's not really representative of how the money is being used.

But if Social Security continues to be funded at the same rates that it is now, you actually fare better and get more income from Social Security than if you were investing in getting a 7% average return and then doing a 4% save withdrawal.

But we know Social Security income averages are around $1,800 a month per person and $2,800 per couple. So when we're trying to think about whether or not you are saving enough and you're unsure how to account for this future potential income, you might consider writing off something in that ballpark for your spending. For example, there's a feature in the Financial Independence tab of the Wealth Planner that allows you to input pensions and the year that you expect to receive them. So we are building out a more robust pension and Social Security section of the Wealth Planner for 2025. But in the meantime, I input 80% of this average for married couples into an example timeline and I think the results are incredibly instructive and honestly quite optimistic. All numbers are approximate here by the way. So do me a favor, tape your eyes open if they aren't glazed over already.

Okay, so we've got a married couple. We are assuming they have $100,000 in combined household income with about $6,000 in household expenses, which are both rising income and expenses by around 2% per year with nothing currently invested. They're about 40 years away from retirement assuming that they begin investing the post-tax difference between their roughly $72K per year in spending and their $100,000 in gross income, which is about $13,000 a year. I wanted to know how 80% of the current $2,800 average married couple benefit would impact this couple's timeline. So to do so, I accounted for 30 years of 2% inflation, and I adjusted their average Social Security payment for what it would be in future dollars. It ended up being closer to $4,000 after 30 years of cost of living adjustments. And it actually shaved around six years off their FI timeline, give or take, because it lowered the amount that their investments needed to produce each month, thereby lowering the overall amount they needed to personally save and invest of their post-tax income.

So put another way, 80% of the average benefit today is about $2,240 for a couple like this, $2,240 a month that account for a full 37% of their monthly spending. And this tracks right because it is estimated that these benefits typically replace roughly 40% of someone's income on average given the cap on earnings that are taxed. My guess is that this is more true for median earners, but regardless, after considering Social Security, they need to accumulate around $2.2 million on their own for their investments to produce the income they need before Social Security. And considering the additional years of inflation, their fine number was closer to $3.8 million. So we dropped from $3.8 million to $2.2 and this by the way assumes that they continue to be taxed as though they're earning an inflation adjusted a hundred thousand per year. So it is inclusive of tax considerations because it's estimated that roughly half of Social Security beneficiaries in 2022 had income that exceeded thresholds for taxation, meaning they had to pay taxes on at least a portion of their benefits.

All that to say their fine number lowered by a whopping 42% when we added in the inflation adjusted Social Security payment that represents 80% of today's average for a couple. In that respect, if you're not factoring this in at all into your FI calculations and assuming your investments will need to produce enough income to cover all of your expenses, it's likely that your estimates for what you need to save are way overshooting like maybe to the tune of between 30 and 40%.

Henah pointed out while we were editing this episode that some of the numbers we were tossing out there might be confusing because we produced an episode in the past about how 40% is the ideal save rate and she was like, and now you're saying that they might be saving 30 to 40% too much. So what gives Katie to which I was like, Henah, nobody is that big of a scholar of the Money with Katie lore, but just in case you are, I want to take a moment to clear that up in case anyone else is drawing a parallel between those two numbers and is getting confused.

40% is what we've identified as the ideal save rate as defined by the point at which you hit diminishing marginal returns for your efforts because after that 40% mark each incremental 5% increase in save rate only buys back a year or two of time, as opposed to the jump from a 10% to a 15% save rate, at which point the increase is going to buy you back seven years of time. So that's really focused just on diminishing marginal returns.

Now when I estimate that your fine number might be 30 to 40% too high, we're not talking about your savings rate, we're talking about the goal investment number itself and the fact that it might be too high if it's totally ignoring eventual Social Security income. It's a coincidence that they're both around 40%, but these numbers are not related in any real way beyond the fact that if your fine number is lower, a savings rate of 40% is going to get you there a lot faster regardless if you're planning to retire early or you want to prepare such that you could fund it if you needed to take an unplanned early retirement, your fine number might still be accurate.

You're just likely to end up with more than you need once you hit your late sixties. And at some point I want to run the numbers on how to factor in eventual Social Security payments for very early retirees because I do think the implication of a new source of income in your sixties is that you're going to need a lower fine number now in early retirement or that you maybe could be withdrawing more than 4% since the amount your investments need to produce later will be lower, thereby making it less crucial that you preserve all the principle.

A recent Goldman Sachs report found that 51% of respondents who are currently retired reported that they are living on less than 50% of their pre-retirement annual income, including 29% who report living on 40% or less. Only 25% of them generate what many estimate as the amount needed to maintain their standard of living of 70% or more. And when they look into why this might be, the report finds that the role of choice, or I guess the lack thereof in retirement is to blame. 56% of retirees reported retiring earlier than planned and almost half of them retired due to reasons that were out of their control. So that's like one in four people are retiring due to health issues, losing their job, caring for family, et cetera, which reduces the time that they have to save for retirement. Only 7% of retirees—7%—reported retiring simply because their savings were sufficient to fund it.

And finally, the great wealth transfer. This is one of those “if it happens, great, but I wouldn't count on it” considerations. The great wealth transfer or what we have dystopically named the fact that boomers are rich as hell and they're going to leave a lot of money to Gen X and millennials. I do think it's interesting that this mass transition event is being framed as a “great wealth equalizer” like, oh, the millennials, they're finally going to be able to buy houses, because it's expected that trends in the wealth transfer are going to mirror existing wealth in equality.

Roughly 55% of boomers reported that they'll be passing down $250,000 or less, and the Federal Reserve's analysis shows that millennials who are already in the top 10% of the income distribution are twice as likely as millennials in the bottom 50% to receive an inheritance. This quote comes from New York Magazine, “The millennial rich and upper middle class will be the wealthiest people America has ever known working class millennials meanwhile are poised to enjoy less economic security than their parents as their wages failed to keep pace with the rising cost of housing and healthcare.”

So that's depressing. I guess what I'm trying to get at here is that I don't know that the great wealth transfer is something that I would necessarily hang my hat on as the way out or something that you really want to be leaning heavily on when you're planning for your own retirement.

And you might be listening to this like, wow, this episode is ending the way most CNBC articles about 20-year-old millionaires start by mentioning the importance of inheritance. But it is, I guess, a valid while bleak consideration that you might want to keep in the back of your mind. According to NBC, many young people are actually overestimating on average how much they stand to inherit. So I might not count on it unless your last name is Zuckerberg.

But more than anything, I hope this exercise leaves you feeling hopeful that you're either trending way ahead of schedule or alternatively that you're actually not as far behind as you might've thought you were. I know I've made jokes about pyramid schemes, but there's an interesting discussion to be had here about how we think about our investments and historical average returns as a given for all the jokes we make about Social Security being a failing system.

There could be an argument made that current workers subsidizing retirees and those workers being subsidized by future workers at infinitum is in some ways a safer bet than relying on the idea that the US stock market will continue to produce 7% per year average real returns, or at the very least, it's a different kind of risk. Though there are risks that are almost certainly related when we think about this bigger picture question of the sustainability of long-term growth. All that to say it might not be such a bad thing to be producing income in different ways.

And I admit that I have a renewed appreciation for Social Security after researching writing this episode. It also made me want to go deeper on two other topics. Bill Perkins' Die with Zero mentality and the idea that passive investing and index funds themselves function a little like a pyramid scheme too. But that's for another time.

And that is all for this week, and I will see you next week, same time, same place on The Money with Katie Show. Our show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin with our audio engineering and sound design from Nick Torres. Devin Emery is our chief content officer and additional fact checking comes from Kate Brandt.