Social Security may be in worse shape than many advisors (and retirees) thought. The Congressional Office Budget is now reporting that the combined Social Security retirement and disability trust funds will be depleted in fiscal year 2029—five years earlier than the trustees of the two funds had projected earlier this year in their annual report.
As a result, the CBO is expecting that Social Security benefits will need to be cut by 31% beginning in 2031 if no changes are made to the program. The Social Security Trust Fund had previously projected a 21% reduction in benefits beginning in 2034. The CBO estimates that the disability trust fund will be "exhausted" by 2022, and that the Old Age and Survivors Insurance trust fund--commonly known as Social Security--would be exhausted by 2030.
The differences between the two estimates are due primarily to different projections on four components; the CBO's projections on the following are lower than those by the Social Security Trust Fund trustees:
- earnings subject to the program’s payroll tax
- labor force participation rates, productivity growth, lower inflation—all components of nominal GDP growth projections
- fertility rates (though CBO projects larger improvements in mortality rates than the Social Security Trust Fund)
- real interest rates (adjusted for inflation) in the long run
The CBO, for example, is projecting that the real rate on the 10-year Treasury note will reach 1.7% in 2026, and continue to rise to 2.3% in 2046, remaining at that level indefinitely, according to testimony from CBO director Keith Hall before the House Subcommittee on Social Security Committee in late September.
The Social Security Trust Fund, noted Hall, is projecting 10-year real rates at 2.4% in 2016 rising to 2.7% in 2031 and remaining at that level thereafter.
Regardless of whether CBO or the Social Security Trust Fund projections prove to be more accurate, Social Security benefits are likely to be cut if the government doesn’t make some changes in the way the program is financed or makes payouts because the number of recipients is rising faster than the number of contributors to the fund at least for the next 40 years or so.
“For the program to be self-supporting, current and future generations would need to pay more in taxes than they receive in benefits to offset earlier participants’ larger benefit-to-tax ratios,” according to the CBO.
Financial advisors have known for years that payouts from Social Security may decline.
“None of this is new,” says Daniel Galli, president of Daniel J. Galli & Associates in Norwell, Massachusetts, who’s a CFP and registered representative and IAR for Ameritas Investment Corp. “They have been printing this information on benefit estimate statements for years.”
He says advisors must discuss with clients “how they want to incorporate Social Security planning” into their financial plans. “The reality is that Social Security will be the most powerful retirement benefit for most Americans. Even building in a 21% discount is an important part of planning. “
Rose Swanger, an advisor with Royal Alliance Associates near Knoxville, Tennessee area, is discounting even more than that.
“Whenever I do a comprehensive financial plan with clients," Swanger says, "we automatically cut the future Social Security benefits 25%-30%. I tell all of my clients that if by the time they retire they are still able to receive 100% [of their projected] Social Security benefits, good for them. Otherwise, they need to focus on how to save, and save more, at the present time.”
Among the adjustments she’s been suggesting are Roth conversions in order “to avoid the nasty surcharges for the Medicare part B & D premiums.”
Michael Palazzolo, a financial advisor with Fintentional in Birmingham, Michigan, recommends that clients 55 or older use the projected benefit amounts listed on their Social Security Benefit statement. However, he also runs two scenarios for clients aged 55 or older who are worried about Social Security: one with benefits rising annually at 1% to 2% and a second scenario with no inflation adjustments.
For those under age 55, Palazzolo recommends running scenarios using 70% of estimated Social Security benefits and an inflation adjustment of 1% to 2% and, if they’re interested, a second scenario with the full amounts of their estimated benefits.
“Regardless of client age, changes to the investment strategy should be minimal,” says Palazzolo. “It would not be prudent to make up a retirement income shortfall due to anticipated Social Security changes by taking on too much additional investment risk. At most you might consider an increase in overall stock exposure of 10%.”
The CBO makes no recommendations in its report for shoring up Social Security. The Social Security Trust Fund has offered several options in the past, including increasing the payroll tax, raising or eliminating the ceiling on income subject to the Social Security tax and increasing the full retirement age.
Such potential changes would require Congressional action, which is possible given the new Republican Congress. Rep. Sam Johnson (R-Texas), chairman of the House Ways and Means Committee’s Subcommittee on Social Security, recently released a plan to reform Social Security that would drastically reduce benefits. Paul Ryan, the Speaker of the House, has favored a “premium support” plan for Medicare, which the Wisconsin Republican said would transform it from single payer system financed by the government to a health care plan by which beneficiaries could use their government benefits to buy private insurance.
President Elect Donald Trump said during the presidential campaign that he would not change Social Security. However, his pick for the head of the Department of Health and Human Services, Rep. Tom Price (R-Georgia), favors Medicare reform similar to Ryan’s. As head of HHS, Price would also sit on the Board of Trustees for Social Security.