For good reason, many retirees and pre-retirees are worried their Social Security benefits will be cut. Nearly two-thirds of American seniors rely on the program as their primary source of income, according to the Social Security Administration, and 10,000 more Boomers are retiring every day.
The situation only seems more dire when you consider the last few years’ Trustee Reports, which project a trust fund depletion around 2034 – a stat politicians and pundits are eager to point out. With an ever-increasing ratio of retirees to workers, it makes sense that seniors are uneasy about the program’s future.
Still, there are a variety of proposed solutions, several of which Congress has successfully implemented in the past. From means testing to tax hikes to raising the full retirement age, these fixes run the gamut in terms of political feasibility and potential efficacy.
Nobody can predict politics, of course, but clients’ perceptions can significantly impact their choices in retirement. The fear that benefits will be cut leads many seniors to collect early, forfeiting significant chunks of their checks for life. On the other hand, overreliance on future benefits can lead to inadequate savings, poorly timed drawdowns and, ultimately, a lower quality of life in retirement.
As an advisor, you don’t have a crystal ball. However, it is important to help your clients paint a realistic picture of Social Security’s reliability, so they can make informed choices based on their savings, goals and risk tolerances.
An Evolving Program
“Social Security certainly was never intended to be someone’s full retirement,” says Steve Weisman, Esq., estate planning lawyer and founder of Scamicide.com. When Congress implemented the program in 1935, the full retirement age was 65, while the average life expectancy was 62. There were also more than 10 workers for every beneficiary at that time – a stark contrast to the roughly 2:1 ratio we see today.
“It was just supposed to be something that would help, but that purpose has changed over time,” Weisman adds. With the average retirement lasting almost 20 years, even conscientious savers assume Social Security will cover a large portion of their expenses – a little more than half, according to Nationwide Retirement Institute research.
Still, the drastic demographic change since the program’s inception should send a strong signal to clients: don’t rely too much on Social Security. Between benefits taxation, retirement age increases and an increasingly impotent cost of living adjustment, it’s clear that Social Security’s spending power is decreasing.
One thing that’s remained the same, however, is the way the system is funded. “It’s a pay-as-you-go system, yet people think they have an account they’ve paid into,” says Chris Markowski, founder of Markowski Investments and personality behind Watchdog on Wall Street. Payroll taxes are the program’s primary funding source, and the remaining 20 to 30 percent comes from benefits taxation, general fund reimbursements and bond interest. The pervasive idea that you “get back what you put in” causes much of the confusion we see today.
The Forecasted Shortfall
The Social Security Board of Trustees says the Trust Fund will be depleted by 2034 – but what does that really mean? “The projected shortfall compared to payouts is not as bad as it seems,” says Weisman.
With its combination of payroll taxes, bonds and accrued bond interest, the system is currently operating at a surplus, albeit in the face of liabilities. 2034 is the year in which the fund is expected to run out, at which point current payroll taxes would be the only funding source. The oft-cited report also points to a 2.83 percent 75-year actuarial deficit, which is the reason why, if Congress did nothing for 17 years, benefits would be cut by 23 percent.
There are several ways Congress might address that deficit. One of the most impactful would be a 1.4 percent payroll tax increase for employer and employee each – certainly not a popular measure, but arguably more voter-friendly than slashing seniors’ benefits. That increase alone could account for the deficit for the next three generations, according to the Trustees’ current projections.
Another proposal is an increase in the full retirement age – “one of the most likely changes and minimally disruptive to what people are planning on now,” says Weisman. Congress has already bumped the FRA to 67 for people born in 1960 or later, and further increase would have little effect on the current crop of retirees.
Other potential changes include an increase in the FICA threshold, tying retirement age to life expectancy and non-bond investment of Social Security funds. “Many of these solutions, coupled, could cover the shortfall in a way that doesn’t significantly hurt most Americans,” says Weisman. In fact, the Committee for a Responsible Federal Budget has put forth The Social Security Reformer, a free tool that shows the cumulative effect of smaller, piecemeal solutions.
Still, opinions vary wildly on which of these solutions, if any, will pan out. “Cuts may be coming down the pipe, and I’ve been telling people for 20 years not to count on Social Security, and not to rely on politics to solve the problem,” says Markowski. The last payroll tax increase occurred in 1983, and it successfully shored up a much more imminent shortfall. However, in today’s environment of wage stagnation, slow economic growth and rising health insurance premiums, families and small business owners may not be ready or willing to take another tax hike.
If one thing’s likely, however, it’s that none of these changes will take place in the next few years. “Congress is slow to act unless there’s an emergency,” says Weisman. Social Security reform is an evergreen campaign issue, but changes have historically been made in the nick of time.
With so much uncertainty and difference of opinion, it’s tough to determine a course of action. History and political necessity suggest Congress will act at the eleventh hour, shoring up the 23 percent shortfall just before it hits. With an unprecedented retirement wave at hand, however, it’s tough for clients to remain optimistic when their retirements are on the line.
“Be more responsible than Congress,” suggests Weisman. “Plan earlier, and take advantage of the many programs and tax-qualified savings vehicles available now.” From HSAs to Roth IRAs to lifetime annuities, there are more opportunities than ever to tax-efficiently provide for lasting retirement income.
More conservative, less optimistic clients may want to rule out Social Security altogether, viewing it as a potential bonus on top of an already adequate series of assets and income streams. “I think advisors should prepare their clients with things they can control,” says Markowski. “There’s a price that comes with living an extra 10 years, and you have to put away the extra money.”
Regardless of your clients’ levels of optimism, however, collecting early is probably still a poor choice. While a lack of Congressional action may lead to a 23 percent shortfall, collecting at 62 will reduce benefits by 25 percent for life. Assuming average or above average longevity, delaying will be a wash at worst - but a tremendous boon if benefits are preserved.