Saturday, July 26, 2008

New Social Security retirement benefit estimator: a good step, but improvement needed

SSA has released a new online version of the Social Security Statement, which allows users to electronically access an estimate of their future Social Security benefits, as well as to alter assumptions regarding future wages and the age at which they will retire. This is a good step forward in helping Americans plan for retirement.

However, the new online calculator needs to be clearer about the benefit estimates it provides. The calculator does not specify whether dollar figures are in "current" or nominal dollars, meaning the actual dollar amount you would see on your check when you retire, or in today's dollars, meaning dollars adjusted for inflation to give a better feeling for the purchasing power of your future benefit.

In fact, as discussed in this op-ed, the Social Security Statement and the new online calculator don't do either. The benefit estimate is expressed "wage indexed" dollars. Technically, this means that the future dollar amount is discounted by the rate of compound wage growth between the time the estimate is made and the time of retirement. (If you want to do the math, the wage indexed benefit , where Bc equals the current or nominal benefit amount, g equals the average rate of nominal wage growth, and n equals the number of years until retirement.

Here's an example: let's say that the nominal benefit amount you would receive – that is, the actual dollar figure on your monthly Social Security check – would be $2500 and you have 20 years until you plan to retire. Typically, you would either think about the benefit in nominal terms or, better, convert it today's dollars to better represent what the benefit can actually buy. Assuming 2.8 percent annual inflation, as the Trustees do, the benefit in today's dollars would equal $2500/(1+0.028)20, or $1,439.

However, expressed in wage-indexed dollars the figure will be significantly lower. Assuming that wages rise 1.1 percent faster than inflation (as the Trustees projection), the wage-indexed figure would equal $2500/(1+0.039)20, or $1,163, a difference of $276 per month.

The new calculator is at least superior to the Statement, which says that benefits are "in today's dollars" – meaning inflation-adjusted dollars, when they're not. But first, it's not clear how helpful the new calculator will be when it does not even state what terms the benefit figures are in, and second, even if that were made explicit, it's not clear how helpful a wage-indexed dollar amount is.

Why? The purpose of a benefit estimator is so that people can determine whether they're saving enough on their own to provide for a comfortable retirement. Remember, Social Security wasn't intended to cover all retirement needs. Most people who have a defined benefit pension receive an estimate of future benefits in nominal terms. For people estimating the benefit payable from a DC pension, such as a 401(k) or IRA, they'll either project it in nominal or in real terms. (For instance, this retirement income calculator from AARP deals mostly in today's dollars, as does this 401(k) calculator from Quicken.) To be useful in making comparisons, a wage-indexed Social Security benefit figure must be converted to either nominal or inflation-adjusted dollars, which is well beyond the skills of the typical person even if they knew the conversion needed to be made.

Again, at the very least, users should be notified of what kind of dollars their benefits are estimated in. Preferably, they would be given a choice between nominal and inflation-adjusted dollars, and provided with information on what each figure means.

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