A couple of days before her 18th birthday, my daughter asked, “Will I get any Social Security?” At the same instant, I replied “absolutely,” another adult at the table offered a “Hell, no!” setting off a flurry of statements from the others at the table about how the system is in dire straits. I sat and listened.
What I heard was a fundamental lack of understanding of how Social Security works, often expressed by regurgitating sound bites from cable news. These are well-educated people from both ends of the political spectrum, yet they had it all wrong. How they got to this state is quite understandable.
These days, thousands of places provide erroneous or misleading information -- TV, radio newspaper, magazines, blogs and social media, to name a few. Headlines like “Financial Outlook Dims For Social Security” or “Social Security Slipping Closer To Insolvency” from well-known media properties add to people’s anxiety.
Those headlines are not wrong. The trustee’s report on the Social Security Trust Fund indicates it will be “exhausted” by 2033, three years sooner than projected the year prior. It was only 2029 back in 1994 and 2042 in the 2003 projection. Every year the report comes out, the issue gets coverage, as it should. It is important. It is news.
One practical issue for financial planners is that even in years that the fund improved its position, the stories inevitably turn into a “Yeah but….” discussion because the trust fund still exhausts at some point. This feeds the fear. It is probably only going to get worse.
Michael Astrue of the Social Security Administration practically begged writers not to scare the public about losing benefits. He explained, "Please, please remember that ‘exhaustion’ is an actuarial term of art and it does not mean there will be no money left to pay any benefits" he warned in issuing the trustees' 2012 annual report on the financial health of the Social Security program.
Some of the press took Astrue’s admonishment to heart, but others did not. What many failed to mention from that report was that the Social Security Trust Fund had reserves of $2.7 trillion and took in $69 billion more than it did in the prior year, including the interest on bonds.
So, when the question came, “Hey, Dan, what do you think?” I explained that keeping misinformation and misinterpretation from generating poor financial decisions is a permanent part of the job description of financial planners. I then went over the basics and we talked about what it all may mean or not mean.
Social Security is funded through payroll taxes. These taxes are collected from wage earners and their employers, and benefits are paid from these receipts. When more is taken than is needed for benefit payments, the excess goes into the trust fund, where it is invested and earns interest from special issue U.S. Treasury bonds.
Social Security is a government program, the bonds are government securities, and the government spends more than it brings in. Often, what happens is people then reframe those facts and say things like “Congress has already spent the money in the trust fund and all that is left are worthless IOUs.” Some call that a practical interpretation, others a fear-mongering politicization. Regardless of what you would call it, there are real securities in the trust fund and the fund collects interest at an attractive rate.
By law, Social Security can not borrow money, so when tax receipts plus interest are not enough to pay benefits, the trust fund will be tapped. The trust fund’s exhaustion comes about because as the baby boomer generation reaches retirement age, they stop paying payroll taxes and start getting benefits.
The system is at the point where the crossover from a growing trust fund to a shrinking one is starting. The projected exhaustion date comes sooner when the economy is weak and later when the economy picks up, but the demographics dominate the projections.
So if Congress does nothing and the trust is exhausted, what happens to benefits? As Mr. Astrue explained, "After 2033, even if Congress does nothing, there will still be sufficient assets (from payroll taxes) to pay about 75 percent of benefits. That's not acceptable, but it's still a fact that there will still be substantial assets there," The long-range actuarial shortfall is projected to be just 2.67 percent of taxable payroll.
What does this mean for planners and their clients? There are four broad outcomes. 1. No changes to Social Security are made and benefits are not cut. 2. Changes are made and no benefits are cut. 3. No changes to Social Security are made and benefits are cut. 4. Changes are made and benefits still get reduced.
No one knows which combination will result, but no. 1 seems least likely. The other three strike me as real possibilities.
One of the pervasive complaints about the system is that it is as it is, largely because it is politically untenable to cut benefits. There is also a societal motivation to pay promised benefits. According to the National Academy of Social Insurance, for half of married couples and two-thirds of singles over age 65, Social Security is their largest income source. A 25 percent cut would be painful for many recipients.
If a change to the benefits were to occur, it would probably be more subtle than a 25 percent across the board cut. Politicians are just not likely to tell an 85-year-old widow she will get less, unless maybe she is rich. Maybe additional taxes on benefits will come or maybe not. Wealthy seniors have always been a good source of campaign funds.
Benefits could also be reduced by lowering or eliminating the key levers in claiming strategies: delayed credits, restricted applications, and the ability to file and suspend. That would certainly put a wrinkle in some plans. Though President Obama, recently suggested changes to spousal claiming rules, there is no momentum for this, today. One reason for the lack of interest is the dollar amounts affected by the claiming strategies are tiny relative to the scope of the funding issue.
Changes to the funding side of the trust fund equation seem more likely. This has been done many times in the past. Extending the start dates for benefits by a year or two, an increase in the payroll tax rate, an increase in the cap on wages subject to payroll taxes ($117,000 in 2014), or a combination of these would bring back balance. It wasn’t popular at the time, but Congress did this in 1983 and those changes pushed solvency out 50 years.
What am I telling clients about Social Security and how do I incorporate Social Security into their planning? First, I remind clients that neither they nor I nor anyone else can know the future. Planning is about preparation, not prognostication.
Second, I am comfortable admitting I do not like the current state of affairs. It stinks. The trust fund is exhausted just before my full retirement age, but more concerning is that my children and their cohorts may face a more substantial burden.
Nonetheless, I tell them that we must proceed with the way things are and I go over all the facts and theories about Social Security. What I don’t do is use the same misinformation about the system being bankrupt or rhetoric about IOUs. What I want is a rational discussion focused on each family’s circumstances.
For clients receiving benefits or soon to receive benefits, I am comfortable assuming that their benefits will be close to what they have been promised, if not all of what was promised. The older they are, the more comfortable I am with a full benefit assumption. The most likely change is more taxes on Social Security for higher-income retirees, but that is not imminent. Changes to claiming strategies are probably irrelevant to anyone in their late 60s. Probably.
For younger people, I will gladly work with an assumption that payroll taxes will be higher than today’s arrangement and benefits will be lower than currently promised. However, assuming no benefits will be there is overly pessimistic, in my view. Most clients don’t assume more than 25-30 percent less than current benefits.
Of course, planning is a process, not a one-time event, so we will revisit these assumptions and adapt to whatever changes may come.
What are you telling your clients?
Dan Moisand, CFP, has been featured as one of the America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager, and Worth magazines. He practices in Melbourne, Fla. You can reach him at [email protected].