When one advisor told her client that she may have to work longer than she intended, at a job that she really didn’t like, the client was dismayed. She knew she had meager savings stashed away in an IRA, but she had been counting on her Social Security benefits to make up the shortfall. “My advisor told me that it’s possible that when I’m in my 80s, Social Security might only be able to pay 75% of the benefits I’m expecting to get,” she explains.
News stories predicting the demise of Social Security, or that the program’s $2.6 trillion trust fund will run out in 2033 are legion. Advisors often warn their clients that they shouldn’t count on anticipated Social Security benefits as part of their retirement package.
But there are also experts who say that rumors of the program’s death have been greatly exaggerated. They argue that Social Security, a program that began back in 1935, and that has never missed a payment, is unlikely to be left short of funds by Congress. In fact, the same boomers who are seen as taxing the system’s ability to pay are the very ones who will make the already influential senior lobby about 50% larger and significantly bigger as a share of the total electorate in 15 years. That suggests Social Security will have an increasingly powerful lobby working on its behalf as time goes by.
If advisors genuinely doubt Social Security’s ability to pay promised benefits, they should be discounting those benefits in recommending savings and investment programs to clients. But if they’re wrong to worry, and Social Security is actually a sound bet, such a conservative strategy could be encouraging clients to save more than they need or work longer than they have to.
Jim Holtzman, an advisor with the Legacy Group in Pittsburgh, says while benefits are probably secure for people already retired or nearing retirement, he is concerned that Congress might not fix the projected shortfall that would hit in 2033, when without any fix, the program would only be able to pay 77% of promised benefits. Another worry? That politicians might fix things by reducing benefits for future retirees who are younger. “We typically factor in only 50% of estimated Social Security benefits for our younger clients because of that uncertainty,” he says, “and some of them tell us we should just leave Social Security out all together.”
That’s taking a lot of money off the table when planning for most people’s retirement needs. The average Social Security benefit in 2015 is $1,218 per month, or $14,616 per year; $29,232 per year for couples.
A LITTLE TWEAKING
Michael Kitces, a partner and director of research at Pinnacle Advisory Group in Columbus, Md., says, “The idea of telling people of any age that Social Security won’t be around for them when they retire is [very miguided]. And even the idea that benefits are going to be cut when the trust fund is run out is absurd. It’s not a political reality. Just a 3% increase in the payroll tax—1.5% for employees and 1.5% for employers—fixes the system for the next 100 years.”
LEARNING FROM THE PAST
Problems with Social Security in the past were even more drastic yet were fixed in time, notes Rob Kron, head of retirement education at BlackRock.
“In 1983, Social Security’s funding was up against a wall. It was within a year of running out of money, which would have meant benefits would have to be paid just from the money coming in from the payroll tax of current workers.” President Reagan and Congress fixed things by gradually raising the full retirement age from 65 to 66 and eventually, for those born after 1960, to 67, and by increasing the payroll tax in steps.
Kron adds, “I’m confident Congress will eventually do something this time too. I certainly wouldn’t tell anyone to count on a reduction of benefits in 2033, but I encourage young clients to focus not on Social Security, but on saving.”
Peter Diamond, emeritus professor at MIT and Nobel laureate in economics, has, together with a colleague, Peter Orszag, vice chairman of corporate and investment banking and chairman of the Financial Strategy and Solutions Group at Citi, and former head of President Obama’s Office of Management and Budget, assembled a list of ways that Congress could fix Social Security.
Diamond acknowledges the system does need some Congressional tinkering, but says a solution needn’t be that costly or disruptive. Among the suggestions the two have made:
- Raising the FICA tax by 1.2% on employers and employees each, a small bump which would fully fund Social Security for the next 75 years.
- Raising or eliminating the cap on income subject to the payroll tax—currently set at $118,500 and adjusted annually.
- Raising the full retirement age slightly to account for increases in longevity.
- Lowering benefits slightly for wealthier Americans.
The important thing is that the sooner Congress acts, the smaller the fixes have to be, since there is a longer time for those fixes to rebuild the trust fund, says Diamond. Diamond notes that Social Security, since its inception in the New Deal, has “always operated in crisis mode.” He explains, “When Social Security was created, Republicans were heavily opposed. When President Clinton proposed putting some trust fund monies into an index fund, Alan Greenspan said it ‘threatened our freedom.’ So whatever we do with Social Security will be the usual compromise between what people want as beneficiaries, and those who are ideologically opposed to the program.” But he adds, “No politician will say they are in favor of cutting Social Security benefits for anyone.”
In terms of how advisors should deal with the issue of Social Security’s future benefits, he says, “Anyone who would significantly discount the value of estimated Social Security benefits or count them as zero is misguided. If you’re going to make predictions about a client’s portfolio, the stock and bond markets dwarf any risk concerns about Social Security benefits. And it’s not as if your 401(k) or your IRA are totally reliable either.”
Stephen Goff, chief actuary at the Social Security Administration, notes that company pensions are almost gone, and personal savings have also taken a hit this century, with a “lost decade” in 2000-2010 for stocks, and a decline in home equity values. That makes Social Security more critical for the nation’s elderly and disabled.
THE BEST ROI
Social Security secure enough that, far from discounting future benefits, Alicia Munnell, director of Boston College’s Center for Retirement Research, argues that advisors should recommend to any clients who are feeling financially strapped and thinking of taking their benefits early, to draw on other investments, even 401(k) or IRA funds, and wait until 70 to get the maximum benefit.
Kitces agrees, saying that simply waiting until 70 to collect can be “the best long-term return money can buy.”
Indeed, for an average middle-class person age 66 with $1,800 monthly Social Security benefit, matching that with a privately issued annuity that has an inflation adjustment and spousal benefit, according to Fidelity Investment’s online annuity calculator, would cost $500,000.
As BlackRock’s Kron notes, to the extent that Social Security benefits can cover a client’s or couple’s expenses, they are free to take more risk with their invested assets.