The Solvency of the Social Security System
As the Social Security Board of Trustees takes a closer look at the effects of the pandemic on the solvency of the Social Security system, many advisors are in an excellent position to address client concerns about the future of Social Security. Get started with your clients now by outlining how you could manage the Social Security shortfall and stress testing retirement strategies against benefit cuts. Learn more about the Social Security trust fund in this month's 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 on 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 I'm also a practicing financial advisor. Welcome to another FinPlan Friday. Here in 2021, we're going to be experiencing many after-effects of the pandemic. Last year was incredibly rough for many people around the country. We're starting to see some signs of life, and hopefully, you see that in your area too. We're also going to be peppered with news, and one of the big news items we expect is the release of the Social Security Trustees report. Every year, the Social Security Trustees make projections about how long Social Security trust funds will last. They also make projections about what will happen when the Social Security trust fund is depleted, as it will inevitably be.
Reports on the Social Security Trust Funds
Social Security was intended as a pay-as-you-go system. But with baby boomers working and fewer of the greater generation collecting benefits, we built up reserves in the Social Security trust fund. We've begun to spend into those reserves.
The 2020 trustees report came out in April, but at that point, they could not have anticipated the effects of the pandemic, and so it came out with a disclaimer that it did not include the impacts of the pandemic. At that point, the trust funds were projected to run out in 2035, with roughly 75% of benefits payable after that. Even after trust funds had been exhausted, approximately 75 cents on the dollar would continue to be paid in then-current tax revenues.
Now, several reports came out through the course of last year. Probably the most alarming suggested that trust funds could run out as early as 2029, and at that point, only pay 69% of projected benefits. After that report came out, several others came out, including an estimate by the Social Security Trustees last November that suggested that maybe 2034 would be the date of depletion. Still, in that estimate, 75% of benefits would be payable after the point of depletion. And so what we're expecting is a trust fund report suggesting a 2034 or a 2033 depletion date in the future, then somewhere in the neighborhood of 75% of benefits payable thereafter.
Some of the Biggest Concerns People Have
"Social Security is going broke. I need to claim as soon as possible to get as much money out of the system as possible."
Now that's an unfounded belief because there would be current tax revenues after that point. Frankly, the idea of Social Security benefits going to zero is not an idea you should be afraid of. It's not a reason to claim early. Now it does make sense to stress test a plan and say, "If Social Security benefits were cut by 25%, is my plan still okay." If it is, then you should follow one of the optimal claiming strategies. If it's not, you need to look at the overall financial plan and identify what places it would give. Identify where there is extra room. Does someone need to work longer? Does someone need to spend a little less now to have a cushion?
Ultimately we don't anticipate a full benefit cut becoming a reality. Still, as we get closer to these deadlines, you will hear more about the potential for Social Security going broke And so the fear level among the consumer base out there, those folks who are on the edge of claiming, is going to go up, which increases the potential for poor decisions. So, as an advisor, you have an opportunity right now to educate the public on what does it mean when they say, "Social Security is going broke?" It doesn't mean the system won't pay a dime of benefits. Instead, what it means is that the trust funds would be depleted, and current tax revenues would only support round numbers–roughly 75% of benefits. What does it mean to your client's financial plan? Does that mean that they run out of money ten years earlier? Or does it mean that they need to cut $300 out of their lifestyle today or work one or two years longer?
So, when you think about it that way, we have a great opportunity as advisors right now, particularly as the news cycle heats up. When the new trustees' report is eventually released, we have an excellent opportunity to educate consumers and help them avoid a knee-jerk reaction to something that sounds terrible. It sounds awful when you hear, "Social Security is going broke."
There are a variety of tools out there. We've just updated our Social Security Timing software to allow you to model a benefit cut. And in most cases, you see a break-even point for clients that moves by a period of three to four years. That's roughly what a full benefit cut would represent. For most people in average or better health, their life expectancy would suggest at least one member of a household delay. The higher wage earner should still generally delay, even if we experienced a full benefit cut.
Full Benefit Cuts Are Unlikely
A full benefit cut is highly unlikely. Some combination of changes is very likely to happen. Some of the potential changes are:
- An increase in taxes on current workers–that has happened periodically throughout history
- A change in the Social Security formulas generally means those changes tend to benefit lower-wage earners and penalize higher-wage earners. Now, does that mean that we should expect a higher wage earner benefit to go away? Not at all, but what it does mean is that we might see a haircut, or we might see an additional bend point in the formula that would reward the highest wage earners less for their much higher taxes that they pay on Social Security benefits.
- We might see changes to the taxation of current benefits. Right now, the most you can be taxed on a Social Security benefit is 85 cents of the Social Security dollar gets taxed as ordinary income at your ordinary income tax rates. Now that could change. A hundred percent of benefits could be taxable for some people.
- Full retirement age is probably another one that likely will move, and it historically has moved. Back in 1983, the full retirement age was 65. And then, over the next 40 years, it moved up to age 67. So for those people born in 1960 or later, the full retirement age is two years later than their grandparents' full retirement age.
Some combination of those changes is likely to happen, which is why we likely won't see that full headline benefit cut, but even so, it makes sense to plan for it. Be prepared for it. Help your client understand that it doesn't mean that Social Security benefits will go away. Instead, it means we'll likely see some combination of reform. We may see some benefits cut, but even with a full benefit cut, it probably doesn't have the disastrous impact on their plan that a headline might lead them to believe. So, this is an excellent opportunity to go out and educate your clients. And we're happy to help you with both communication materials and software to help you analyze the impact of a potential benefit cut both on the claiming decision and then also in the overall financial plan.
See the Impact
Show clients how benefit cuts could affect their retirement strategy with our free Social Security benefit cuts calculator. Plugin year of birth, benefit amount at FRA, percentage of benefit cut, and the year the benefit cut occurs, instantly seeing the impact.