Early Retirement

Study #290 - How Generous Are Social Security and Medicare?

It is commonly understood that Social Security replaces about 40 percent of preretirement earnings for average workers. But what are we trying to replace? And why? If the real goal is to maintain consumption during retirement at levels comparable to preretirement consumption, preretirement earnings are not a very good guide. Fringe benefits comprise a growing share of preretirement compensation, particularly health insurance.

The wages that Social Security payments are based on are essentially cash wages. They do not include noncash employee benefits. However, these fringe benefit dollars either allow direct consumption (in the case of health care, for example) or later consumption (as is the case with 401(k) contributions, for example). Thus, including fringe benefits would give a more accurate picture of earnings available for consumption. If preretirement health care dollars are added in and payroll taxes that fund Medicare are subtracted out, Medicare dollars net of premium payments should be added to Social Security to get comparable consumption figures for the years of retirement. Also, since payroll taxes that fund Social Security and Medicare are not available for consumption, these taxes should be subtracted from preretirement income along with other labor taxes to give a more accurate gauge of preretirement consumption opportunities. With these adjustments, the government replaces 85.3 percent of price-indexed preretirement "consumable income" for the average worker.