In April 2015, Gov. Chris Christie of New Jersey made some strong recommendations about the need for changes to Social Security. One facet of his 12-point plan was to increase the full retirement age for future retirees. However, that idea wasn’t nearly as alarming as his second recommendation, which was a form of means-testing that would start reducing Social Security benefits for retirees with income of more than $80,000 per year and completely eliminate these benefits for retirees with more than $200,000 in income annually.

While many agree that changes need to be made to the Social Security system to restore long-term solvency, the second part of Christie’s proposal failed to take into account the ripple effects that his plan would have on middle-class retirees. Christie cited Warren Buffett as an example of someone who doesn’t need Social Security, yet Buffett is hardly representative of the folks who would be affected by this means-testing proposal—particularly those individuals who are closer to the middle or at the bottom of the sliding scale of benefit decreases.

How Are Retirees Choosing To Take Their Benefits?
In order to more fully understand the side effects of a proposal like this on retirees across the country, it’s important to understand what most are doing with their Social Security elections. In particular, when are they starting to collect? We can then look at different income groups and study their spending patterns to infer what might happen if more affluent retirees were to lose a significant portion of their income in retirement.

In the nation as a whole, more than 95% of both men and women are collecting Social Security benefits at full retirement age or younger. This means nearly all Americans are starting to collect benefits between ages 62 and 66. If we break down the numbers by each age, approximately 40% of the population is taking benefits as soon as they are eligible, at age 62, according to the Social Security Administration.

So what is causing retirees to take their benefits so early? Many financial planners know that a strategy that involves some element of postponing benefits until a later age to earn delayed retirement credits (8% per year from full retirement age to age 70) may be extremely beneficial to securing long-term financial stability. Therefore, retirees could be drawing benefits early for several reasons:

•  Lack of education: Perhaps they do not truly understand the impact of taking benefits early instead of taking them later.

•  Fear: They might think, “I should collect now before the system is broke!”

•  Financial need: Applicants have not saved enough for retirement and might go into credit card debt if it weren’t for their Social Security income.

•  Their underestimation of life expectancy: Applicants think they won’t live into their 80s, even though statistics by the Society of Actuaries show that a 65-year-old, non-smoking female has an 80% chance of living to age 80 and a 40% chance of living to age 90.

 

Since the strategies that we, as advisors, may typically recommend to a client (“file and suspend” or a “restricted application”) must occur at full retirement age or beyond, the claim data suggests that the majority of retirees simply aren’t implementing these strategies. Why? Likely because they do not have the luxury of choosing to delay benefits until a later age, or they are not working with financial advisors who can help them make educated decisions about this significant asset.

Where is the Money Going?
So how are retirees spending Social Security dollars? In January 2014, J.P. Morgan released a paper by Katherine S. Roy outlining the results of a study the firm conducted on spending and retirement, drawing on data from 1.5 million U.S. households. These households have mortgage, debit and credit card relationships with Chase and use those payment types for most of their spending. While the group represents a national sample, it skews heavily toward regions in the Chase ‘‘footprint” (the New York tristate area, the Midwest, Florida, Texas and most of the West).

If we look at households with $1 million to $2 million in assets and compare how much 65-year-olds are spending on various expense categories (health care, housing, education, entertainment, etc.) to how much 90-year-olds are spending, we see interesting things. One thing that caught my eye was that spending on education increased almost as much as spending on health care. We can probably assume that Grandma and Grandpa are helping pay for their grandchildren’s college tuition bills. If they were to lose part or all of their Social Security benefits because of means-testing, I imagine that education spending would be trimmed before health-care spending. This is exactly what the means-testing solutions do not take into account: the ripple effects on different parts of our nation’s economy.

A few other areas of discretionary spending that could be affected are charitable giving and state income taxes. Of course, I don’t mean retirees could choose not to pay their California state income taxes if they were residents. I simply mean that if their income resources are squeezed, that could create a higher incentive for them to relocate out of high-income-tax states (such as New Jersey, California and Iowa) to lower-income-tax states (Nevada, Florida and Texas).

 

I’m seeing this already with many of my clients; many of them are choosing to relocate to states with a lower cost of living. In fact, we were seeing this phenomenon so often in my firm, RegentAtlantic, that we released a white paper on the topic in 2014. Cutting Social Security benefits for retirees, particularly those who have less time to plan for the decrease in income, might increase this exodus from high-cost states and increase the pressure on those states’ already struggling economies.

For most of my clients, the biggest areas of discretionary spending are gifts to charity, help with grandchildren’s college education, travel and assistance to children or other family members who are struggling to make ends meet, particularly with child care, medical and housing expenses. These areas of spending typically only stay in my clients’ budgets as long as their primary goal of maintaining their own retirement lifestyle needs has been achieved. Social Security benefits play a significant role in achieving that goal.

If taken away, the benefits would not only likely affect the lifestyle of the retirees themselves, but the effects could ripple in other areas of our economy—namely in costs of higher education for those who cannot afford steep tuition, in lower contributions to charities that help the most vulnerable members of our society and in less support for family members who need help meeting basic living costs. If income sources dry up, it is likely that the spending on these discretionary areas would dry up, too, putting increased pressure on our nation’s middle- and lower-income classes.

Means-Testing: Punishment For Savers
The final concern I have with Christie’s means-testing proposal is that it has relatively low income thresholds before benefits are reduced. That means punishing people who have been prudent spenders and savers their entire lives. These individuals might have accumulated large balances in their retirement plans because they lived well within their means, only to face larger required minimum distributions upon reaching age 70. If so, is it fair if their Social Security benefits are taken away? Someone who earns the same amount over his or her lifetime but spends it all instead will have no reduction in benefits because he or she has no minimum distributions to speak of. Does that make financial or ethical sense?

While I certainly agree that the Social Security issue needs to be addressed—and sooner rather than later to avoid more drastic measures—proposals needs to consider the impact on all retirees and not just the Warren Buffetts of the world. In addition, an equitable proposal should not penalize retirees who planned for their future.

Amanda Lott, a CFP licensee and wealth advisor with RegentAtlantic and co-chair of the firm’s financial planning committee, specializes in the analysis of Social Security benefit options.