Wade Pfau, Ph.D., CFA, RICP®

Potential Directions for Social Security

I’m cynical; for my retirement planning I assume that I’ll pay into Social Security until I stop working and I assume that I’ll draw nothing out i.e all cost, no benefit. This is a ‘worst case’ so anything else with any benefit will be a pleasant surprise.

– A reader at the Retirement Researcher blog

A common argument for claiming Social Security early is that the program is about to be dramatically overhauled in a way that leaves retirees attempting to get a little out of the system before it’s gone. But it seems rather unlikely that any impending reforms would leave near retirees with significant reductions to benefits.

The widespread belief that Social Security is bankrupt and about to disappear has existed for a long time. I can remember walking around Washington, D.C., in the late 1990s and receiving literature suggesting there were more Americans who believed UFOs visit us on earth than who believed Social Security will be there when they retire.

I commonly hear from individuals that they will plan for retirement assuming there will be no Social Security, and any benefits they do get will be icing on the cake. While I generally support conservative assumptions for planning purposes, I think this viewpoint is taking things way too far. For my own personal planning, my conservative planning assumption is that I will receive 70% of my presently-legislated projected benefits.

While Social Security definitely has funding problems, the situation is not quite so dire as to think it will disappear entirely or otherwise be converted into a pure welfare program. The general goal of reforming Social Security is to help place the Trust Funds into 75-year actuarial balance.

The 2015 Trustee’s Report estimates that the current Social Security system is not generating enough revenue to stay in balance past 2033, and that an immediate increase in the payroll tax of 2.62 percentage points (shared between employees and employers) would be needed for the Social Security system to maintain its solvency for the next 75 years. If no action is taken, Social Security benefits would have to receive an across-the-board 21% reduction so that the inflows of new contributions from workers could cover the outflows of benefit payment.

The presently legislated course for Social Security includes a continued increase in the full retirement age to 67, an OASDI payroll tax of 12.4%, the use of CPI-W to make annual cost-of-living adjustments, and the use of the average wage index for indexing benefits at the age of first eligibility.

There are a multitude of ways in which Social Security reform could proceed to get Social Security back on track to a 75-year actuarial balance. Many reform options would have minimal impact on current or near retirees. Options include any increase in payroll tax rates, or a lift in the ceiling on maximum taxable earnings, which is $118,500 in 2015. With payroll tax increases, only those still in the workforce would be affected for the tail end of their careers.

A gradual increase in the full retirement age consistent with the 1983 reforms would also not affect those already near retirement. Another popular reform idea is to switch from “wage indexing” to “price indexing” when calculating Social Security benefits. Though this sounds somewhat technical, it would allow current or near retirees to escape the burden of reform. Instead, reform would compound over time so that younger individuals will eventually receive lower and lower benefits relative to their wages and payroll taxes. As an attempt to look out for young people, I oppose this reform for its particularly stark intergenerational impacts.

Finally, a reform that would not affect benefits is to expand the investment approach of the Social Security Trust Fund to include additional investment options beyond the current specially issued non-tradable Treasury bonds. This reform was discussed during the 1990s, though nothing ever became of it. Finally, the reform idea popularized by President Bush in the 2000s was to carve out a portion of Social Security payroll taxes to create Personal Retirement Accounts. This reform also did not make it far into the legislative process.

Reforms Impacting
Current or Near Retirees
Other Reforms
Use a Smaller COLA Increase payroll tax rate
Use more than top 35 years of earnings Increase maximum taxable earnings
Link Benefits Reductions to Longevity Improvements Gradually Raise Full Retirement Age
Eliminate “file and suspend” & related strategies Switch from “wage indexing” to “price indexing”
Means Testing for Benefits Expand Trust Fund Beyond US Treasuries

There are other reform ideas which could also impact current or near retirees today. A number of these reforms would lead to some benefit reductions in the near term.

For instance, Social Security benefit growth could be linked to a new price index which grows less rapidly, or the cost-of-living adjustments (COLA) could be set at 1% less than the consumer price index. The impact of this reform would be to gradually reduce the real purchasing power of benefits over time. The justification for such a reform is that the current CPI-W measure used by the Social Security Administration may overstate inflation and that people tend to spend less as they age. Objections to this reform include that it would leave the extreme elderly and widows more vulnerable to poverty, and it may be the case that expenses for some vulnerable elderly would rise faster than the CPI-W.

Other reforms which would lead to benefit reductions include increasing the number of years used to calculate the average-indexed monthly earnings. This would bring in more years with lower earnings to reduce average wages. Congress might also eliminate strategies like “file and suspend” which would impact the more well-informed beneficiaries who are aware of these more sophisticated approaches.

A popular reform internationally is to provide a more direct and automated link between longevity improvements the full retirement age. The idea is that over time, the full retirement age would increase automatically as people continue to live longer, which would better calibrate the number of years that they would live beyond this age.

Finally, a reform which could have a bigger impact on wealthier individuals who are about to retire is the introduction of means-testing for benefits. Those with sufficient means, represented either through other income sources or wealth accumulations, would no longer be eligible to receive Social Security benefits. Such a reform would run counter to the entire history of the Social Security program, which has always sought a clear link between benefits and contributions. Means testing would convert the Social Security program into a welfare program. In this regard, it seems unlikely that such a reform could happen, though politicians do discuss this possibility from time to time.

Other reforms which increase the progressive nature of the benefit formula or increase taxes due on benefits could provide stealthier ways to arrive at the same outcomes as means testing, but without formally making the link for benefit reductions.

While higher income individuals may have some justification to worry about means testing, it seems incredibly unlikely that a wholesale reduction in benefits would be enacted for the general population of current and near retirees. It is overly conservative for near retirees to believe they should start benefits ASAP to get whatever they can because they are worried that Social Security will soon disappear.

Next, read How Long Can Retirees Expect to Live Once They Hit 65.

Retirement Researcher is a SEC registered investment adviser. The content of this publication reflects the views of Retirement Researcher (RR) and sources deemed by RR to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.

The information throughout this presentation, whether stock quotes, charts, articles, or any other statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission there of to the user. RR only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. It does not provide tax, legal, or accounting advice. The information contained in this presentation does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material, discuss your individual circumstances with professionals in those areas before making any decisions.