10 Jun 2016 Should You Count on Social Security?

A frequent question from both young and old clients is “Will I get my benefits?” You might be surprised to learn that the Social Security Program is not as bad off as you might think. That said, the program will be changing in the next 20 years, so it behooves the thoughtful planner of every age to consider and be ready for possible worst cases, while there’s time to replace possible gaps in retirement income.

Today’s Brief takes a close look at the current status of Social Security and its expected solvency, costs, and benefits for the next 75 years. Most of the information and supporting facts come from reports on the Social Security Website , including a 2010 article written by Stephen Goss, Chief Actuary of the Social Security Administration.

Since 1935, the SS program has paid uninterrupted benefits to millions of recipients as prescribed by the law. But the Program has been modified by Congress several times during its 81-year history. According to the SS website, at the end of 2014, the Social Security program was providing monthly benefits to about 59 million people: 48 million from the OASI Trust Fund and 11 million from the DI Trust Fund. Total benefit payments for the year were $849 billion: $707 billion from the OASI Trust Fund and $142 billion from the DI Trust Fund.

Social Security is a PayGo or a ‘pay as you go’ system. Benefits going to today’s SS recipients are paid by today’s wage earners. Workers and employers pay a combined 12.4% tax on wages into the Social Security Trust Fund each year. Social Security differs from other government services and agencies in that its operations depend solely upon wage tax funding – it cannot borrow.

There are two distinct operations in the Social Security System; Old-Age, Survivors Insurance (OASI), and Disability Insurance (DI). The supporting tax funds or trust funds are most often lumped together in reporting.

Social Security is currently running a surplus, meaning more wage taxes are coming in than benefits are going out. According to the Social Security website, as of the end of 2014 the year’s surplus (tax receipts beyond program costs or benefits) added $25 billion ($5.7 billion more than estimated in 20130) to asset reserves of the combined OASI and DI Trust Funds, bringing the total to $2.79 trillion. This surplus increases the trust funds to 308% of the annual expenditures estimated for 2015.

The trustees project that the combined OASDI Trust Funds will continue growing until 2019 as total annual income exceeds total annual costs. Beginning in 2020, however, they project the OASDI annual cost will exceed total income, so the trust fund reserves will be drawn down until they are depleted in 2034—one year later than estimated last year. After trust fund reserve depletion, continuing income is sufficient to pay 79% of program cost, declining to 73% for 2089.”

Mr. Goss points out that the SS system has faced difficulties before. “Historically, the OASI and DI Trust Funds have reached times where dedicated tax revenue fell short of the cost of providing benefits and also times where the trust funds have reached the brink of exhaustion of assets. For years 1973 through 1983, the combined OASI and DI Trust Funds were operating with a negative cash flow that was depleting the trust fund reserves toward exhaustion. The Social Security Amendments of 1977 and 1983 made substantial modifications to the program that reversed the cash flow of the program to positive levels and caused the substantial buildup of assets to the [$2.79] trillion that exists today. The 1977 amendments included a fundamental change in the indexation of benefits from one generation to the next. The 1983 amendments included increases in the normal retirement age (NRA) from 65 to 67 and the introduction of income taxation of Social Security benefits with revenue credited to the trust funds.”

It is important to emphasize that negative cash flows (wage tax revenues do not cover SS benefits) do not necessarily mean that the trust funds are moving toward exhaustion. It is most often likely that trust asset earnings will grow faster than benefit costs. In 2010, the time of Mr. Goss’ article, the long-term average real interest rate on US Treasurys was assumed at 2.9%, and real (growth in excess of inflation) growth of OASDI program cost  was projected to average about 1.6% from 2030 to 2080. Mr. Goss says “A cash flow shortfall, therefore, is only a problem if it is large and persistent enough to cause the trust fund reserves to decline over time toward exhaustion.”

We face such a situation now. Birth rates in the US averaged over three children per woman during the baby boom period from 1946 to 1965, but rates dropped to just two children per woman by 1970 and have remained mostly level since. This apparently permanent shift toward lower birth rates in the United States is the principal cause of our changing age distribution between 2010 and 2030, according to Mr. Goss.

For the past 35 years, there have been about 3.3 workers per SS beneficiary (30 beneficiaries per 100 workers). After 2030, the ratio will be two workers per beneficiary (50 beneficiaries per 100 workers).

With the average worker benefit currently at about $1,000 per month, 3.3 workers would need to contribute about $300 each per month to provide a $1,000 benefit. But after the population age distribution has shifted to have just two workers per beneficiary, each worker would need to contribute $500 to provide the same $1,000 benefit.

In 2010 the Social Security Board of Trustees recommended to the US Congress that immediately reducing Social Security benefits by 13% or increasing the combined payroll tax rate from 12.4% to 14.4%, or some combination., would be sufficient to allow full payment of the scheduled benefits for the next 75 years.

The cost of kicking the can down the road is huge. According to Mr. Goss’ 2010 article “The intermediate projections of the 2009 Trustees Report indicate that if we wait to take action until the combined OASDI trust fund becomes exhausted in 2037, benefit reductions of around 25% or payroll tax increases of around one-third (a 4% increase in addition to the current 12.4% rate) will be required.

We are fond of blaming our elected leaders for failing address this growing problem. The last substantial Social Security reform occurred in 1983 under President Ronald Reagan. Presidents Bush, Clinton, Bush and Obama were not able to do so. President Obama and Congress were able to agree to eliminate the increasingly popular ‘file-and-suspend’ maneuver which allowed for a sort of ‘double-dipping’ into benefits for eligible couples.

As the political climate grows increasingly noisy and contentious, chances of fixing Social Security seem more remote, especially because the remedies are so immediately felt by so many –wage earners and benefit recipients. To get a sense of just how complicated and prickly, from a political perspective, fixing Social Security is, try this interactive tool on the website of the Committee for a Responsible Federal Budget. My solution spread the pain evenly and came pretty close to closing the gap in the 75^th year. Give it a try.

It remains unclear how Congress will address the looming shortages in Social Security, but remedies will probably include a combination of tax increases and benefit reductions. Young clients working and saving for retirement will be hit twice. Rising payroll taxes will reduce your ability to save while the need to save will increase in order to replace reduced Social Security benefits. Older clients approaching retirement or in retirement may see their benefits reduced in the next 5, 10, or 20 years by as much as 10% to 25%.

Regardless of what age group you fall, changes to our nation’s retirement system are coming. Plans should be stress-tested to see how they stand up to worst case scenarios you and we agree are possible. If you haven’t reviewed your plan lately, give us a call or make an appointment online. We’d love to catch up – and to ensure that you are on track to meet or exceed every goal you value.