HOLLYWOOD, FLA. How can we fix Social Security to be a strong and solvent system for the next 75 to 100 years? Author Brian Doherty outlined a couple solutions at the Bank Insurance & Securities Association conference here, which, although politically unpalatable, still offer lessons for advisors.
One idea is to eliminate the maximum salary threshold for FICA taxes, Doherty said. That maximum is currently $115,000, so any level of someones salary above that threshold is not subject to the taxes that pay for Social Security. If it were instead operated like Medicare, where all salary is subject to the tax, then Social Security would be fine for most of the next century. Doherty noted that only a small portion of the population (5%) make more than $115,000 so the vast majority of Americans would likely support a move to eliminate the maximum. Still, a political decision that alienates the highest 5% of earners is not likely anytime soon.
Another idea would be to raise the FICA tax that now funds Social Security. It stands at 12.4%, half paid be employer and half by employee. If it were raised 2 percentage points (with just one point on the employee), that also would keep the system solvent for decades. Or, a solution could combine elements of those two possibilities: a smaller tax hike, and an increase (but not the elimination) of the maximum threshold.
Even if these solutions are not politically possible, advisors still need to know the facts, he says. Whenever a client says, I think Social Security is in trouble, the advisor needs to have an answer ready. Or else, he says, that conversation is over.
The real reason people claim SS benefits early can be described with marshmallows, Doherty said. He cited an experiment from the late 1960s where four-year old kids were told they could have one marshmallow now, or wait for 15 minutes and get two marshmallows. The majority of kids (75%) took the one marshmallow after holding out for an average of three minutes. Why? In laymans terms, people want instant gratification. In finance terms, people are bad at deciding on a realistic discount rate when valuing different options.
The kids and marshmallows led to a series of experiments with adults and money. And researchers concluded that we internalize choices regarding money with an astounding 345% discount rate. That is, if we wait, we want 345% more for the delay.
All of this plays into one of the most important financial decisions that people will ever make: deciding when to file for Social Security. And advisors need to be prepared to explain the consequences, Doherty said.
The fact is, he maintained, the SS system is amazingly generous in many ways, offering some features that no private company could match. Only the government could do this, he quipped. And advisors need to be able to frame the discussion properly in order to help clients.