As one of the foundational building blocks of many retirement planning strategies, Social Security income and the associated claiming strategy are critical pieces to incorporate into almost every cash flow plan. So it’s well worth our time to comb through the projections and conclusions of the latest data in order to ensure this critical assumption used in the cash flow plan is up-to-date. The important 270-page Social Security Trustee’s Annual Report was released on May 6th with headlines indicating the projected year for “insolvency” for the Social Security Trust Fund is now 2035 as the downward trend in the ratio of workers to beneficiaries continues unabated. (In 2023, there were about 2.7 covered workers for each beneficiary but by 2035, it’s estimated this will now be 2.3 to 1.) To clarify, “insolvency” means that 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. This means unless Congress steps in to make changes, 2035 is projected to be the first year when payroll tax collections won’t keep up with benefits payable. A 17% reduction in Social Security benefit payouts will be required to keep the system sustainable, followed by a reduction of 27% around 2098. Keep in mind, these projections are educated guesses at best as this reduction projection is an improvement from three years ago when the benefit reduction in 2033 was projected to be closer to 24%.
But let’s clear one thing up right away: A dramatic 17% reduction in Social Security benefits is not going to happen. Why? Two reasons: First, too many people depend on Social Security for almost all their retirement income, and second, major cuts to existing benefits would almost certainly be political suicide to most if not all members of Congress and whoever sits in the White House.
Regarding the importance of Social Security: According to the Social Security Administration, about 40% of people aged 65 or older receive 50% of their family income from Social Security and about 15% rely on Social Security for 90% of their income. And according to Center on Budget and Policy Priorities, without Social Security about 40% of adults age 65 or older would have income below the poverty line which means these payments lift 15 million people out of poverty. It’s clear that substantial benefit cuts to the most vulnerable would be devastating.
Which brings us to the political implications: Retirees and people of retirement age are the most active voting bloc in the electorate and likely the most substantial campaign donors. According to 2022 US Census data about 65% of US citizens 45 and older voted in the November 2022 election. This contrasts with an average of 38% voting participation for those 18-34 years old. 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 approach 90%.
What Can Be Done to “Fix” Social Security?
The good news is that 2034 is still a decade away and by implementing some relatively modest changes soon, Social Security benefits can most likely be stabilized to much firmer financial ground. This is not without precedent. Back in the early 1980’s, similar circumstances faced the Reagan administration. To address the deficits, the Social Security Amendments of 1983 were passed that started 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 1960 or beyond. Here’s an easy math question: In 1983, how old were people born in 1943? (40) How old were people born in 1960 in 1983? (23) That’s the point.
Today, several measures can also be taken to address the 2024 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) inflation-related calculation to reduce how annual benefit increases are currently calculated. (Note: it is currently estimated the 2025 benefit increase could be 2.5% - 3% due to recent inflation measures, down from 3.4% in 2024 and 8.7% in 2023)
- Increase wages subject to the 12.4% payroll tax (6.2% for employees, 6.2% for employers) at a level greater than the first $168,600 (current level) to a higher wage level or even uncapped.
- 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 to 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 earliest 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 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 to capture earlier, lower earning years to reduce average wages used to calculate benefits.
Of course, none of these potential changes would be viewed positively in general but to make it more palatable and given the aforementioned voting bloc data, it’s highly unlikely anyone over the age of 60 would see major changes. In all likelihood, any and all changes were targeted at those under age 40. In addition to these potential changes, there’s always the federal government’s favorite tool to address funding problems: more debt. When you own the printing press, this can easily be executed. But as we’ve seen in the last few years, this is not without inflationary consequences.
Planning Strategies for Social Security
Using history as a guide can be helpful but not always a perfect tact to plan for the future. The world is much different today compared to 1983 and there are many other factors that need to be considered with respect to assumptions around Social Security. Certainly, current government debt and spending levels, tax rates, and the global economic conditions stand in stark contrast to almost 40 years ago. Realizing this, we think it wise to take a conservative approach to assumptions for Social Security benefits moving forward. It is virtually impossible to capture all the potential changes around benefit growth, benefit ages, taxation levels, etc. but it’s a good practice to segment expectations based on the age of the retiree.
In short, it is prudent to assume little to no changes to current benefits for those age 60 or older. It’s a good idea to at least lower the inflation factor assumed in the annual benefit increase. For those under 50, a wise approach would be to find the current expected Full Retirement Age benefit (can be downloaded from www.ssa.gov with the annual Social Security statement) and reduce it by a modest percentage, maybe 10% or 20%. This will capture some reduction from the current estimate for future benefits. These aren’t perfect calculations or estimates but they are likely directionally correct. We would much rather be wrong to the upside on our assumptions, especially when it comes to retirement cash flow.
For our clients, there’s no substitute for a detailed and personalized retirement cash flow estimate, customized to their actual life circumstances and integrating the Social Security claiming strategy and estimated benefits. We don’t default to simplistic “rules of thumb” when it comes to retirement planning, especially with Social Security, and we stress test scenarios to consider in real-world factors such as client spending levels, retirement savings, tax attributes of retirement accounts (impacts tax burden of withdrawals), inheritances, legacy goals, and family health history.
Bottom Line
Social Security is a bedrock of retirement planning, and a key planning assumption in almost every wealth planning scenario. But for current retirees or those expecting to retire in a few years, we highly doubt major benefit reductions will affect those over the age of 55 or 60. It is more likely changes will impact much younger workers. But given the critical nature of this retirement income stream, it’s crucial to employ a detailed and conservative strategy to plan for the far-reaching effects of what could be a 30+ year source of income.