Social Security is a touchy subject. Because of its political and emotional attachments, it also one of the more misunderstood areas of financial planning. As I’ve watched the attitude toward Social Security evolve, retirees claiming benefits early seems to be a popular strategy due at least in part to the perceived insolvency of the program.
“I’m going to get it while it’s still there.” is a popular refrain. Many times, I hear retirees talking about Social Security in a similar vein as waiting in line for a new release at a movie theater. It’s as if they will finally get to the ticket window to claim their benefits only to be told that the guy in front of them got the last one. Because of the federal government’s ability to tax, Social Security just doesn’t work that way despite the reputation it has within the retirement community. Therefore, I believe it is more of a perceived risk rather than an actual risk.
One of the primary reasons for the current poor fiscal health of the Social Security program is the significant increase in recipient longevity. It’s why I spent my last article discussing that very subject. This is not only a significant risk to the typical American retirement but extends to the Social Security program itself.
The Social Security Administration is also commonly spoken about with some disdain. However, once many retirees have their first experience with the Social Security Administration (SSA), their opinions often shift to the positive. I’ve run into very few people that have anything but nice things to say about the various SSA employees, often commenting on how helpful the staff was to them.
As for the overall health of the Social Security program, it’s better than many people lead on. This is mostly due to the fact that the focus is primarily on the shrinking “Social Security Trust Fund” as if that is the end of the program and ignore the current Social Security taxes being brought in year after year. Many of the people that I speak with generally have one of two beliefs associated with the long-term fiscal health of the Social Security Program:
- They believe that all the money they’ve paid in through their working years has been sitting in reserves earmarked to be paid out to them once they retire and is therefore now being compromised due to fiscal irresponsibility.
- They believe that the Trust Fund is where all the payments for their future benefits reside, and therefore the overuse of that Trust Fund may cause their benefits to be sacrificed.
Many retirees don’t realize that Social Security has operated primarily as a pay-as-you-go system throughout its history. Currently, as an employee, you pay 6.2% of your income up to 127,200 to Social Security, and your employer matches that contribution. Once Social Security collects those taxes from your paycheck, they are not invested for your future use, but almost exclusively used to provide benefits for current Social Security recipients.
The Trust Fund as many people refer to it was created in 1939 as part of the Amendments enacted that year. When the Social Security program runs a surplus, meaning more money is flowing into the Social Security system than what is being paid out as it did during the peak earning years of the baby boomer generation, the surplus is invested into the Trust Fund. As for why the Trust Fund will begin shrinking as of this year – baby boomers are now retiring in droves. So, there is a corresponding bulge causing outflows to exceed inflows, which in turn requires additional funds from the Trust Fund to meet the shortfall.
Up to this point, the current benefits have been paid from a combination of the current inflows from payroll taxes and the interest earned on the Trust Fund principal. In this calendar year, the SSA is expected to begin tapping the principal of the Trust Fund, and this is expected to be the case for the foreseeable future.
As for the impact of the soon-to-be dwindling Trust Fund, according to the Center for Retirement Research’s article, “Social Security’s Financial Outlook: The 2018 Update in Perspective” (Yes, I actually read these things),
And, in 2018, taxes and interest are expected to fall short of annual benefit payments, which requires the government to begin drawing down trust fund assets to meet benefit commitments. The trust fund is then projected to be exhausted in 2034, the same years as in the last Trustees Report.
The exhaustion of the trust fund does not mean that Social Security is “bankrupt.” Payroll tax revenues keep rolling in and can cover about 75 percent of currently legislated benefits over the remainder of the projection period.
As for a potential solution to this problem, again from the Center for Retirement Research:
…Social Security’s long-run deficit is projected to equal 2.84 percent of covered payroll earnings. That figure means that if payroll taxes were raised immediately by 2.84 percentage points – 1.42 percentage points each for the employee and employer – the government would be able to pay the current package of benefits for everyone who reaches retirement age through 2092, with a one-year reserve fund at the end.
So, with what could be considered small changes, promised benefits could be paid through 2092, certainly past the life expectancy of anyone nearing Social Security age today. My hope in sharing this data with you isn’t to minimize the significance of this issue, but simply to show that it is a manageable one.
The potential solution mentioned above is also without making any other changes to the program. There are other possible solutions as well such as increasing the eligible retirement ages for future retirees, increasing or uncapping the earnings subject to Social Security payroll taxes, or a variety of other ideas. It would seem likely that it will be a combination of changes to make up the shortfall and will require some give and take among the Washington elite.
By no means do we know what the outcome will be in Washington, but even if they don’t make any changes whatsoever to the system, the Social Security Administration estimates that they have enough to pay full benefits until 2034. Additionally, they would be able to continue funding estimated benefits at a 75% level well beyond 2034 due to the inflows from the working population.
My goal in writing this is simply to clear up some of the misconceptions around the long-term fiscal health of Social Security as many folks nearing retirement make their claiming decisions. Knowing that the situation may not be as dire as it is often perceived to be might provide the context needed to make a better decision for your personal situation without the fears that are commonly found in the retiree community. I would encourage you to make retirement planning decisions based on what you presently know to be the case rather than what is rumored to be the case and deciding what age to claim your Social Security benefits would certainly fall into that category.
Additional reading: Should You Wait Until 70 for Social Security?
Disclaimer: This material is being provided for information purposes only, should not be construed as a recommendation, and is not a complete description necessary for making an investment decision. Opinions are those of Ashby Daniels and not necessarily those of Raymond James or RJFS. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Investing always involves risk. No investment strategy can guarantee success. Past performance is not indicative of future results. There is no assurance that these trends will continue or that forecasts mentioned will occur. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Raymond James is not affiliated with and does not endorse the opinions or services of independent third parties named herein. Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their reflective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any web site’s users and/or members. Raymond James financial advisors do not render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional.
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