As one of the foundational building blocks of many retirement planning strategies, Social Security income is critical to almost every cash flow plan. So just about any headline casting doubt on its long-term solvency raises retirees’ eyebrows at best and incites near panic at worst. The recent release of the Social Security Trustee’s Annual Report is the latest instance. The 276-page document indicated that the projected year for “insolvency” for the Social Security Trust Fund was pulled forward to 2033 from 2034. This is a result of the Covid-related impacts of lower payroll tax revenue and many people claiming benefits earlier than previously projected. In addition, the number of workers paying in versus receiving benefits is expected to drop from about 3:1 today to about 2:1 in 2033. Without any changes to assumptions for payroll tax collections, retirement forecasts and the current structure for payment of benefits, Social Security reserves will be depleted by then. It’s estimated this deficit would require a 24% reduction in Social Security benefit payouts unless Congress steps in to make changes.
But let’s clear one thing up right away—a dramatic 24% reduction in Social Security benefits is extremely unlikely to happen. There are many reasons, but first and foremost, permitting such a draconian cut would be political suicide to most members of Congress and any President. Retirees and people of retirement age are the most active voting bloc in the electorate and the largest campaign donors. According to 2021 US Census data (which can be viewed here), 70.4% of U.S. citizens 55 and older voted in the November 2020 election. This contrasts with an average of 51.4% voter participation for those 18-34 year olds— and this is without any talk of reducing existing benefit payouts prior to that election. If there’s any talk about reducing existing Social Security benefits before any election, it’s safe to say the older voting bloc would swamp the polls and turnout would be even higher.
What Can Be Done to “Fix” Social Security?
The good news is that 2033 is still more than a decade away. By implementing some relatively modest changes, Social Security can most likely be stabilized. This is not without precedent. Back in the early 1980s a similar adjustment was made by the Reagan administration. To address the deficits, the Social Security Amendments of 1983 were passed. This included taxing some Social Security benefits and gradually increasing the Full Retirement Age (from 65 to 66 for those born in 1943 and beyond and 67 for those born in 1960 or beyond). Here’s an easy math question: In 1983, how old were people born in 1943? How old were people born in 1960 in 1983? That’s the point.
Today, several measures can also be taken to address the current version of the problem. Given how negotiations work in the halls of Congress, we doubt it would be just one or two of the potential changes outlined below, but rather some mixture of many or all these changes.
- Modify COLA (cost-of-living adjustment) calculation to reduce annual benefit increases (Note: It is currently estimated the 2022 benefit increase could be about 6% due to recent inflation measures, the largest increase since 2008.)
- Increase the amount of wages that are subject to the payroll tax (6.2% for employees, 6.2% for employers) at a faster rate. The current cap is $142,800. This could be increased or the cap could be removed altogether.
- Increase payroll tax rate from 12.4% (has not changed since 1990).
- Increase initial Full Retirement Ages from current levels. Currently, Full Retirement Age is 66 if you were born between 1943 and 1954. The Full Retirement Age increases gradually if you were born from 1955 to 1960 until it reaches 67. For anyone born 1960 or later, full retirement benefits are payable at age 67.
- Increase the earliest possible age to claim Social Security from the current age of 62.
- Reduce income level at which Social Security becomes taxable. Under current law, 50% of Social Security income starts to be taxed at $32,000 (married filing jointly) and becomes 85% taxable above $44,000 of total income.
- Increase the number of years used for average wages from 35 years to something higher. This would capture earlier, lower-income years, which would reduce the average wages used to calculate benefits.
It goes without saying that many retirees receiving benefits would not view these adjustments positively. To make it more palatable, and given the voting data, it’s highly unlikely anyone over the age of 60 would see major changes. In all likelihood, any changes would impact those under age 40.
Social Security Planning Strategies
Using history as a guide can be helpful, but not always a perfect way to plan. The world is much different today compared to 1983, and there are many other factors that need to be considered with respect to assumptions about Social Security. A growing population of those over age 65, higher government debt and spending levels, and other differences in the political and economic landscape have changed the dynamics. In light of that, it would be wise to take a conservative approach to assumptions for Social Security benefits moving forward. It is virtually impossible to capture all the potential changes to benefit growth, benefit ages, taxation levels, etc., but it’s a good practice to segment expectations based on the age of the retiree.
For those age 60 or over, we don’t expect many major changes to current benefits. Still, at a minimum, it makes sense to lower the inflation factor assumed in the annual benefit increase. For those under 50, a wise approach could be to find the current expected Full Retirement Age benefit (downloadable from www.ssa.gov in the annual Social Security statement) and reduce it by a modest percentage to capture some reduction from the current estimate for future benefits. We would much rather be wrong to the upside on our assumptions, especially when it comes to retirement cash flow.
Bottom Line: Social Security is a bedrock of retirement planning and a key planning assumption in almost every wealth planning scenario. But we doubt major benefit reductions will affect those over the age of 55 or 60. A more likely outcome is modest changes to much younger workers. Given its critical and long-lasting impact, it makes sense to conservatively plan ahead!