People become anxious and fretful whenever there’s a new report with a death knell for the Social Security trust fund.
The latest—but not the last—alarming press release came from a nonpartisan public policy organization, the Committee for a Responsible Federal Budget. It estimated that a typical newly retired couple could see their benefits cut by $17,400 annually in 2033. That’s the year the trust fund that pays old age and survivors’ benefits is projected to be insolvent.
Agita over Social Security only intrudes on clients' ability to plan and set a course for retirement. I offer these facts and opinions to help you address clients’ fears and steer your conversations down a productive path that could win you more assets to manage.
This Problem Can Be Solved
Social Security has always been a “pay as you go” system. Projections of when the trust fund would become “insolvent” measure when the system will be obligated to pay more in benefits than it collects in workers’ taxes.
How do you correct a revenue shortfall? You raise more money.
Put aside the fringe ideas for “fixing” Social Security, and some are doable, even in today’s fractious political environment. The most powerful ones involve raising the cap on the income cap for the FICA tax that funds Social Security. It’s currently adjusted annually according to the average wage index. This year, it’s $160,200 and estimated to be $170,400 in 2024.
Another proposal would subject some other types of income, such as investment income, to the Social Security tax. Congress has already done that with Medicare with a surtax to fund program improvements as part of the Affordable Care Act 2010.
Lawmakers could also effectively reduce Social Security expenses by increasing the federal tax rates on Social Security income to 100% from today’s maximum of 85%.
Another frequently floated idea would raise the “full retirement age,” when someone is entitled to full benefits, from 67 to 70. But that would burden low-wage earners with shorter life expectancies, often because their jobs were physically demanding, and they couldn’t afford or access quality healthcare.
We’ve Been Here Before
Social Security was in the emergency room before in the early 1980s. Republican President Ronald Reagan and Democratic Speaker of the House Thomas P. “Tip” O’Neill struck a fabled compromise to rescue the system.
Some say a compromise like that could never happen again, but I disagree. All you have to do is look at the recent negotiations that led to a bill signed by President Biden to extend the federal debt ceiling until 2025 in exchange for capping increases in federal spending programs.
Lawmakers act when they find the political cover to do so. The politics of brinksmanship are challenging to watch but unlikely to change soon.
62 Or Older? You’re OK
Historically, changes to Social Security haven’t been applied to anyone who has reached the Social Security minimum filing age, which is 62. Their benefits were safeguarded.
However, your clients in their 60s and older could have to pay more taxes if the percentage of income subject to income tax is increased from 85% to 100%.
Younger clients are those who will experience changes in taxation. High earners could have more of their wages taxed to sustain the Social Security trust fund or be subject to a tax on non-wage income if those proposals grow legs.
Punditry Won’t Solve Problems. But Financial Planning Can
After you acknowledge clients’ frustration over the state of Social Security (and perhaps the republic in general), it’s time to redirect their attention. Paradoxically, Social Security is an excellent place to start.
Ask clients when they plan to file for Social Security. This is critical for clients in their late 50s and early 60s to ensure they choose with open eyes.
Start with educating them about longevity, using one of the many widely available lifespan calculators that allow you to gather data about health, background, income and more to get a personalized (and actuarially tested) estimate of how long clients can expect to live.
Then use a Social Security tool to model how much they’ll earn over that projected lifetime if they file early, at full retirement age, or later up to age 70. At this point, clients often ask questions like, “What do I do next?”
At this point, probe their expectations for family, charity and purpose in their later years and ask if they’d like your help figuring out their retirement income plan. The most motivated will consider consolidating assets with one advisor—you.
Use Asset Location For All It’s Worth
For younger clients, retirement is often not top of mind. They may be more focused on buying a home or paying for their children’s education. Acknowledge the here and now but convince them that retirement savings must also become a priority.
The most important lesson you can give those clients is how asset location will maximize their retirement income by minimizing taxes. The earlier they start, the more they’ll save.
Your advice will include:
• Maximizing contributions to tax-qualified accounts like 401(k)s and individual retirement accounts (IRAs).
• Using nonqualified brokerage accounts to invest in high-quality securities they will buy and hold or those with built-in tax advantages, like tax-free municipal bonds.
With their permission, you will manage these accounts in a coordinated way to minimize taxes on interest, dividends, and realized short- and long-term gains.
While some younger clients may talk about their plans to retire at 50, only those with a large inheritance or fantastic success will have the means to do it. Suggest they look around at their parents, who are still working and supporting and caring for elderly relatives.
Your clients will listen when you change the subject from Social Security to planning for their future. Because if there’s one topic hotter than Social Security, it’s taxes.
Paul R. Samuelson is the chief investment officer and co-founder of LifeYield.