We’ve been hearing about the imminent demise of Social Security for so long that many younger people have written it off as a part of their retirement planning. In that sense, the White House’s recent proposal to move Social Security’s cost-of-living adjustments over to what’s known as chained CPI, thereby reducing the annual increases, can be seen as a minor move.
And that’s far from the only bad news that has befallen Social Security hopefuls. The Social Security Board of Trustees now projects that the trust funds will be exhausted in 2033, which means payouts will be limited to the amount brought in by the concurrent payroll taxes. At that point, the conventional wisdom is that benefits will fall by about 25 percent — unless Congress intervenes sometime in the next 20 years.
Given that Social Security’s been under assault for so long, many advisors are understandably blasé about moving to chained CPI; it could be seen as chipping away at something that’s dying anyway. But Social Security has a much bigger impact on the elderly than is commonly discussed. It’s still a cornerstone of a lot of retirement planning, and for good reason: under the right circumstances, it can be worth a million dollars.
“Social Security, if you plan for it correctly, should be a million-dollar asset and should be accounted for and planned for very prudently,” says Ron Floyd, a managing director with the Hunter Group in San Diego. “You’re looking at a $30,000 per year asset. Let’s say there’s 2 percent inflation, and you’re into retirement for 25 years. Those numbers get very big.”
But that’s with the traditional adjustments based on the consumer price index. Chained CPI will have a subtle but noticeable effect on everyone who gets Social Security. Rather than simply adjusting everything for inflation, chained CPI takes into effect how consumers adjust to higher prices. For instance, if the price of steak goes up by 10 percent in a year, that part of the consumer price index would rise by 10 percent under the existing system. Chained CPI would note that people would react by buying more chicken, and the cost of living increase might drop to 5 percent.
It’s a much more complicated way of figuring inflation, and will be prone to hiccups. Currently, there’s an annual inflation adjustment applied to Social Security, but chained CPI can take years to figure properly. If Congress does try to apply chained CPI on an annual basis, there will likely be subsequent revisions and corrections — meaning the retired could see their benefits decline on occasion when those adjustments are made.
More significant is how the effects of chained CPI will develop over the years. It’s like the magic of compound interest, except in reverse. Let’s say someone is getting $2,000 a month in Social Security benefits. With a 2 percent inflation adjustment, they’d get $2,040 per month in the second year, and $2,438 in 10 years. Knock that down to 1.5 percent in chained CPI, and it doesn’t seem like much difference initially, just $10 less per month in the first year. But by year 10, it’s grown to just $2,321.08, a difference of $116.92 per month, or more than $1,400 per year.
And the longer those retirees live, the greater the effect of chained CPI becomes. By the time a retiree turns 90, at the point they will be most worried about their retirement assets running out, the purchasing power of their Social Security benefits will also have eroded. Chained CPI will have its greatest impact on the very old, those aged 90 and older.
Because those benefits won’t grow as consistently as they once did, it might be more sensible for people to consider waiting until the latest reasonable time to begin drawing those benefits. Since the benefits are larger the longer the retiree waits to begin drawing them, this has always been good advice, but chained CPI really draws a line under the soundness of this advice.
The reason President Obama put the chained CPI proposal in his budget for this year is simple to understand: it would reduce Social Security outlays by $112 billion for the first ten years it’s in effect, according to the Congressional Budget Office. But it remains unpopular with both Democrats and Republicans, so the chances of it becoming law are currently not high. But given the determination to do something about future entitlement spending, it’s something worth being prepared for.
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