The Future of Social Security
The start of 2021 will be marked by the transfer of power to a new president, and while President-elect Biden likely has many items on his agenda that will be of interest to financial advisors, one of the biggest could be Social Security. Record-high unemployment in 2020 has led to many discussions about the uncertain future of Social Security, and it's likely that the Biden administration will start evaluating how to bolster the program fairly quickly. Learn more about how you can help your clients prepare for potential Social Security changes under a new administration in our FinPlan Friday conversation with Joe.
In our video blog series, FinPlan Fridays, Covisum® Founder and President, Joe Elsasser, CFP®, offers his take on the issues financial advisors see every day. Joe is a practicing financial planner with a unique perspective into the challenges for which Covisum provides technology solutions. Join us on the first Friday of every month for FinPlan Fridays, and get helpful tips to grow your financial planning practice.
Hi, this is Joe Elsasser, CFP®, President and Founder of Covisum and also a practicing financial advisor. Welcome to another FinPlan Friday. Today, we're going to talk about Social Security and more importantly, Social Security in a Biden administration, because I think we're going to hear a lot in the next several months about Biden's plans for a variety of programs. Social Security is most likely going to be on that agenda. It's going to be a discussion item primarily because of the high unemployment throughout 2020.
The Solvency of the Social Security System
We're going to hear an awful lot about the solvency of the Social Security system. That's always been a question that weighs on our clients' minds.
- What if Social Security goes broke?
- Shouldn't I claim early?
We've tried to answer that question in a variety of ways throughout 2020, most recently with calculations that would suggest that for most clients, a Social Security strategy shouldn't change. Ultimately it will move the break even point, if you will, between a claim-early type strategy and a strategy that includes some form of delay. But for the majority of people, particularly people in reasonable health, even with an extended break even point, it still makes sense to plan for a Social Security strategy as opposed to planning to claim early.
Benefit Cuts: What are the expectations for reform?
The second major thing that we'll want to do throughout the course of 2021 as we're having these conversations with clients is talk about the possibilities.
There were several major reports that came out through the last year, and one of the worst case scenarios said that Social Security would be broke by 2029. And at that point would only be able to pay 69% of promised benefits. The important takeaway there is that even if Social Security goes broke, that doesn't mean that checks go to zero. It means that checks across the board would be reduced to 69% of what they currently are. Now, it's notable that all of the other studies suggested higher percentages and also later exhaustion dates for Social Security trust funds. So, that's looking at really the worst case scenario, but in reality, is it likely that that worst case scenario materializes? No. It's highly likely that there will be a variety of changes, much like there were in 1983.
In 1983, the Social Security system was literally on the cusp of going broke. It would have gone broke at the end of the year effectively, and the 1983 amendments did a variety of things. They extended full retirement age or pushed out full retirement age, and that was phased in over a period of 40 years.That really does represent a benefit cut though. So, that was one major change. The 1983 amendments also introduced the first tier of taxation—up to 50% of a Social Security benefit. And those changes were able to put the system on solid footing for really the next 30-40 years. That's what we should expect, and that's what we should prepare clients for— a variety of changes.
Extending Full Retirement Age
One of the most likely changes will be a continued increase in full retirement age. The reason it makes sense for so many people to delay claiming right now is because even with a later full retirement age, life expectancies have extended faster than that full retirement age has increased. Even if we see another increase in full retirement age, it's likely that Social Security strategies will still play an important role for clients who are currently retired or on the verge of retirement. So that's one thing that we should expect—a continued change in full retirement age.
They also introduced taxation for the first time in 1983. Prior to that, Social Security benefits were tax-free. Another potential change or cut is a change to the taxation—potentially making an entire Social Security benefit taxable for high wage earners. That's a real possibility. Or simplifying the ways in which Social Security taxation happens—ultimately resulting in higher taxation for most people.
Another change that I think is highly likely, is a change in the consumer price index. We saw a switch in the Tax Cuts and Jobs Act from CPI-W for inflation measure over to chained CPI, and chained CPI just recognizes the buying behavior of people as costs of goods, go up. People substitute less expensive goods that are in a same, or similar, category. For example, if I can't get apples because the price of apples has gone through the roof, I might switch to oranges. Now the chained CPI incorporates that switching behavior that is natural to people, and so while it would result in lower costs of living adjustments, Social Security is still the best inflation protected vehicle we have in a client's retirement income portfolio.
Increase in the Wage Cap
A fourth potential change is an increase in the wage cap or the wage base that is taxable for Social Security. Right now it's about $137,000, and that number could be increased, or potentially uncapped entirely to where the 6.2% employee portion is paid on all of an individual's earnings. But ultimately the point is that there are a variety of changes that are likely to happen, and they'll likely be talked about in the next four years, but I don't think they're likely to be implemented in the next four years. So that's something we'll really want to be talking to clients about.
How Covisum Can Help
I'd suggest that the best process is to plan using the current situation with the current rules, because those rules are much less likely to change for people who are already claiming benefits. But ultimately, we also need to stress test and say, "If any of the potential changes that we see on the horizon happen, how does that impact your retirement income plan? Are you still on solid footing?" And if they're not, we need to build contingency plans. The combination of Social Security Timing® and Income InSight® are ideally suited for both of those planning opportunities.