How Much Pre-Retirement Income Will Social Security Replace?

The Social Security Administration calculates pre-retirement income replacement rates using career-average earnings, but indexed for the growth of wages economy-wide, and it says replacement rates average only around 40%.

However, the Congressional Budget Office (CBO) has performed a new analysis of pre-retirement income replacement rates limited to workers’ last five years of substantial earnings, adjusted for growth in prices. Specifically, the CBO uses the average of the last five years of substantial earnings before age 62.

Overall, a person born in the 1960s who is in the middle quintile of lifetime earnings can expect Social Security to replace 56% of pre-retirement income, the analysis finds. With many in the industry suggesting a 70% to 80% pre-retirement income replacement rate in retirement, this decreases the pressure on individual savings in employer-sponsored retirement plans or other savings vehicles. And these new percentages, compared to the Social Security Administration’s average 40% income replacement, could help individuals better plan for retirement.

The analysis shows replacement rates are much higher for workers with lower earnings—95% for a person born in the 1960s who is in the lowest quintile of lifetime earnings—in part because of the progressive nature of Social Security’s benefit formula and in part because their late-career earnings tend to be lower than their lifetime earnings, which determine benefits. Also, although replacement rates are similar for men and women, they are higher, on average, for men in the lowest household earnings quintile because late-career earnings are lower for men than for women in that group, relative to either gender’s lifetime earnings. By contrast, replacement rates are noticeably higher for women than for men in the highest quintile because, in that group, women’s late-career earnings are below those of men.

However, the CBO notes that with the reported expected insolvency of the Social Security trust funds, the benefits actually paid to certain groups would replace a lower percentage of income than what is scheduled to be paid. For example, a person born in the 1960s who is in the middle quintile of lifetime earnings is scheduled to receive benefits that would replace 56% of pre-retirement income, but if the trust funds’ financials continue as they are, what is actually paid to the person would only replace 49% of pre-retirement income. The CBO report notes that with payable benefits, replacement rates would drop noticeably for people in the cohorts that first received benefits after the trust funds were exhausted.