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New CBO Estimates Confirm: Social Security Benefits Are Modest

Social Security benefits replace only about 40 percent of an average retiree’s recent earnings, new Congressional Budget Office (CBO) estimates show.  The actuaries at the Social Security Administration (SSA) find a similar result using a different technique.  By either measure, Social Security benefits are not overly generous.

Financial planners recommend as a rule of thumb that retirees build a portfolio — from the “three-legged stool” of Social Security, pensions, and savings — that replaces about 70 percent of their previous income.  Social Security gets them only partway there, as the new CBO estimate confirms.  And Social Security’s replacement rate (the ratio of a person’s initial Social Security retirement benefit to his or her previous earnings) will fall as the age for full benefits, which rose from 65 to 66 in the early 2000s, rises further to 67 due to 1983 legislation.  Raising Social Security’s full retirement age cuts benefits for all retirees, as we explain here

Furthermore, rising Medicare premiums will take a growing bite out of beneficiaries’ Social Security checks.  That’s because most beneficiaries 65 and older, along with most disabled workers under age 65, participate in Medicare’s Supplementary Medical Insurance program (“Medicare Part B”) and have the premium deducted from their Social Security checks.  So there’s little room for policymakers to cut benefits without hurting vulnerable retirees.

How to measure Social Security’s replacement rate is a technical question with significant policy consequences.  There are many ways to calculate pre-retirement earnings.  Some measures encompass a person’s entire career; others only cover the years just before retirement.  Also, years of very low earnings due to unemployment or gradual retirement may be unrepresentative. 

Before 2014, the annual Social Security trustees’ report estimated replacement rates for hypothetical workers whose earnings follow a smooth path over their lifetime.  The measure of earnings was the average of a person’s 35 highest years of earnings, adjusted to reflect wage growth across the economy through the year before retirement.  In 2014 the trustees dropped these replacement rates from their report, arguing that they were potentially confusing.

However, the 2015 Technical Panel — a group of economists, demographers, and actuaries appointed by the independent Social Security Advisory Board to advise Social Security’s trustees and staff — recommended restoring replacement rates to the trustees’ report.  In addition to showing replacement rates based on career-average earnings for hypothetical workers, the panel advised, the trustees’ report should show replacement rates based on late-in-life earnings for actual beneficiaries.

The two different approaches turn out to produce essentially the same result.

  • CBO’s new estimates provide replacement rates for a sample of actual workers, following the Technical Panel’s approach.  CBO averaged the last five years of substantial earnings prior to age 62, adjusted for the growth in prices.  For people born in the 1940s, CBO estimates that the mean (average) replacement rate at age 65 is 43 percent and the median (the figure for the person in the middle) is 39 percent.
  • SSA’s Office of the Chief Actuary estimates that the comparable figure using the traditional measure is 40.7 percent.  This is based on wage-indexed, career-average earnings for a hypothetical medium earner born in 1949 and claiming benefits at age 65.

Of course, other replacement-rate definitions will produce different estimates.  But the similarity of the two measures recommended by the Technical Panel is reassuring and should pave the way for returning replacement rates to the trustees’ report.