A new study by the Tax Foundation shows that if a person earning the average wage over time retires in 2016, they could receive $19,646 in annual Social Security benefits. However, if that person also started at age 22 to save 10% of their annual income in an IRA or 401(k) plan, while earning the average wage over time, they could receive an annual payout (annuity) of $57,318 from those savings. They would receive $37,672 more per year in retirement benefits than they would get from Social Security.
Under nearly all of the 400 cases of income and investment studied by the Tax Foundation, the person who invested 10% of their income every year in an IRA or 401(k) would be far better off financially than if they relied solely on Social Security -- and that applies to those making less than the average wage over time and more than the average wage over time.
In their study, Comparing the Returns from Tax-Favored Retirement Plans to Social Security Yields, the Tax Foundation explains that Social Security is "not adequate to replace retirement income." For most people, Social Security needs to be accompanied by savings and employer-provided pensions. "Unfortunately, millions of Americans save too little to support their preretirement living standard after they stop working," reports the Tax Foundation. "Many workers do not have a tax-favored retirement plan, such as an employer-provided pension, a 401(k), or an IRA, to fully fund them when they are available."
Source: The Tax Foundation.
To help people better understand the reality of Social Security, personal savings, and retirement, the Tax Foundation designed a database and chart to illustreate the "major advantages of beginning to save early in life in tax-favored retirement arrangements, and how well private saving can perform relative to the returns available from Social Security."
The Tax Foundation's analysis looks at five workers who started to save 10% of their wages every year beginning at age 22. The 10% in funds were put into a portfolio of 60% stocks and 40% bonds.
The first worker made 25% of the average income; the second worker made 45% of the average income; the third worker made 100% of the average income; the fourth worker made 160% of the average income; and the fifth worker made $118,000 (in 2016), which is the maximum income to which the Social Security tax applies. (The Social Security payroll tax cap.)
As the table shows, the first worker -- who earns 25% of the average wage -- if he retired in 2016, would get $9,111.60 a year from Social Security. His 401(k) savings would equal $179,956.79, and from these savings the person would receive $14,332.84 from an annual annuity payout. He would generate $5,221.24 more through the private savings/investment than through Social Security.
The third worker, who makes the average wage, would get $19,646.40 from Social Security, if he retired in 2016, and $57,318.82 in his annual annuity. That's $37,672.42 more than just Social Security.
For the fifth worker, making the maximun income subject to the Social Security tax, his or her annual Social Security benefits would equal $31,672.80 and their accumulated savings would generate $140,224.27 a year through an annuity.
The Tax Foundation examined "wages, savings, and retirement benefits for people of five lifetime income levels and different marital statuses. The individuals illustrated have wage patterns over their lives derived from a study by the Office of the Actuary…. The actuarial note presents average historical earnings patterns, including probabilities of being unemployed, disabled, or leaving the workforce, for workers earning 25 percent, 45 percent, 100 percent, and 160 percent of the average wage over time, and for people who always earn the maximum wage...."