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Talking With Clients About Social Security’s Finances

How should financial planners respond to client worries about Social Security’s future?

Most Social Security experts assume that Congress will address the program’s financial problems sooner or later. But lately, later looks more likely.

Unless Congress acts by 2035, the mismatch between revenue coming in and benefits going out will require a draconian across-the-board benefit cut as high as 25%, according to projections by Social Security’s trustees. Yet, lawmakers don’t seem to be anywhere near consensus on a solution. Add to that the sensational, misguided headlines we see about “bankruptcy” every year and it’s no surprise that your clients might worry about the future of this critical retirement program.

Some clients might be tempted to give Social Security benefits a haircut in their retirement plans, although the results usually won’t be pretty. But you might also be dealing with client instincts to claim earlier than planned in order to get as much as possible out of a system they perceive as troubled. A study published in 2021 by the Center for Retirement Research at Boston College found that negative news headlines about Social Security’s finances encourage earlier claiming decisions.

I’ve been writing about Social Security for more than a decade, and I’ve always assumed Congress will right the ship before we reach the 2035 deadline. But considering the volatile and polarized state of our politics, it’s now fair to question that assumption. I don’t have a crystal ball, but here are some points I currently consider important for client discussions.

Solutions have been proposed, although you might not like some of the outcomes. One narrative I hear often is that “no one has a plan” to fix the problem. But both political parties have staked out positions.

Social Security’s problem involves straightforward math. The program is funded mainly by the 12.4% Federal Insurance Contributions Act (FICA) tax on wages, which is split evenly by employers and workers. Lower birth rates mean that fewer workers are paying into the system than the growing number of people retiring and collecting benefits. Another cause of the shortfall is rising income inequality. Social Security collects FICA contributions only up to a certain wage ($160,200 this year), leaving a growing share of wages outside the taxable base.

Most Democrats are united on how they want to address the projected shortfall. They would add a new tier of payroll tax contributions for people with incomes over either $250,000 or $400,000, depending on the proposal. Either approach would extend trust fund solvency. Democratic plans also would expand benefits modestly.

The Republican position is more difficult to discern. The populist wing of the party is taking a hands-off approach: former President Donald Trump warned his party not to touch Social Security or Medicare benefits, and House Speaker Kevin McCarthy said that cuts are “off the table.” But neither expanded on how they would avert the 2035 problem.

The Tea Party wing in the House of Representatives has long championed a solution that calls for significant benefit cuts for all but the lowest-income workers by gradually raising the full retirement age (FRA) to 70 and revising the benefit formula to sharply cut benefits for middle-income and affluent workers.

That last point is worth considering carefully: given the opportunity, some in the GOP would dramatically reduce benefits for your clients. They see the future of Social Security mainly as a welfare-style support program for the needy. They would move away from the program’s original design as an earned benefit pension. They also propose linking further increases in the FRA to future gains in life expectancy.

In the Senate, a bipartisan group of lawmakers is considering a plan that cuts benefits in two ways: 1) It would raise the FRA to 70; and 2) change the formula for calculating benefits so that it includes 40 years of earnings, rather than the current 35 years. The latter change would drag down benefit levels for workers with fewer than 40 years of work, as well as for those with very low earnings for some of those years.

The Senate group also calls for borrowing $1.5 trillion to seed a sovereign wealth fund that would enable Social Security to start investing in the stock market.

Higher retirement ages would fall most heavily on your younger clients. The FRA already has been increased significantly under the reforms enacted by Congress in 1983. Before those reforms, it was 65, but for everyone born in 1960 and later, it is 67. Every 12-month increase in the FRA roughly equates to a 6.5% cut in benefits. That means benefits already will be lower for your Gen-X, millennial and younger clients than it is for today’s retirees.

Worst case scenario. If we do get close to the 2035 deadline without a Congressional solution, the most likely scenario is emergency action by lawmakers to avert the severe cuts. Congress could pass legislation that allows the government to divert general tax revenue into the system or to borrow. I say that because it’s difficult to imagine any politician willing to go back home to explain to constituents a decision to allow a 25% cut in Social Security benefits, not only for future retirees, but for seniors already relying on the program.

Allowing the 2035 problem to fester will only deepen public worry about Social Security. As 2035 gets closer, it becomes more difficult to achieve solvency through benefit cuts. That’s because any cuts almost certainly would not be applied retroactively to current beneficiaries.

Delayed claiming remains the best route. Protecting your clients against longevity risk remains critical, so optimizing Social Security continues to make sense, especially for more affluent, better-educated people, since they tend to enjoy better-than-average longevity. 

A recent study co-authored by Boston University economist Larry Kotlikoff, concludes that “virtually all” American workers age 45 to 62 should wait beyond age 65 to collect  Social Security benefits. The researchers found that retirees often give up tens or even hundreds of thousands of dollars by taking Social Security benefits too early. The median loss from early claiming in the present value of household lifetime discretionary spending was a whopping $182,370.

Claiming trends have been moving in the right direction in recent years, but not dramatically. In 2021, 31% of retired worker claims were made by people age 62, down from 60% in 1998, according to an analysis of Social Security Administration data by Richard Johnson of the Urban Institute. But 84% of workers claimed benefits by age 66.

Claiming at the latest age remains relatively rare: just 16% of claims are filed at age 67 or later. That’s not surprising, since only a small share of the population is able to keep working that long. Planners should consider strategies for funding a delay after retirement by drawing down tax-deferred savings in these cases.

Could Congress get its act together to address Social Security’s finances in the near term? Let’s hope so. If not, we could be in for a bumpy ride over the coming decade.

Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to Morningstar and the AARP magazine.

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