Social Security benefits represent the largest asset for many mass-affluent clients, according to a Society of Actuary study titled The Impact of Running Out of Money In Retirement. One way that financial planners can help clients manage this important asset is to make sure they understand how the system works and not get swayed by political posturing, media hype or popular myth.
The amount of misinformation and outright distortion about the workings of Social Security is stunning. In 2000, Al Gore campaigned to create a lockbox to supposedly protect the program assets. In 2012, Rick Perry called SS a Ponzi scheme. There are regular rants from political leaders about the trust fund having nothing but IOUs, or being broke, or how the federal government is raiding it. Some hard facts are in order.
The SS trust fund is the basic account through which the entire program is administered. Throughout the 1960s and 70s the trust fund was not a hot topic, expenses closely tracked income and the trust fund balance hovered from $20 million to $35 million. With an eye toward the huge baby boomer generation retiring in the early 21st century, landmark 1983 legislation shored up the system by raising taxes, boosting inflows and setting the stage to dramatically grow the trust fund. Today that trust fund has over $2.5 trillion in assets.
Like any manager of a large fund, the SS Administration would be foolish to leave the assets idle since inflation would eat up a significant portion of the value. Congress decided that the program could use only one investment option, U.S. Treasury Securities which, last I checked, were still considered one of the safest, lowest-risk investments in the world. In fiscal 2012, the trust fund investments in US Treasury securities paid over 4% interest and generated over $100 billion in interest. So yes, the trust fund is full of IOUs. They are called bonds, and are generally considered a prudent investment.
A more recent SS scare was that just this last year the system was running out of money. What was really happening was that for the first time yearly benefit payments exceeded yearly income from payroll taxes. What was not commonly understood was that total system income was still exceeding expenses. In fact, in fiscal 2012, although benefit payments exceeded tax payments by over $130 million the trust fund balance still grew by $94 million once income from interest, tax receipts and other sources was included.
Another significant source of confusion is the blurring of the different debates about federal budgets and debt and the SS system. Social Security does not contribute to the federal debt. The SS system is in the black. If it runs low on money it cannot borrow, it would have to pay out less in order to balance its books.
The federal government, on the other hand, runs huge annual deficits and has now accumulated over $14 trillion in debt. It needs to constantly borrow money to fund operations. Whether the money is borrowed from Chinese investors, US hedge funds, your grandfather or the SS system is irrelevant. Is this a problem? Sure, but not for the SS system.
Going forward the SS system does have a problem. The trust fund was built up to be spent for the baby boomer demographic bulge. It is projected to be depleted by the mid-2030s. At that time future tax receipts are expected to pay out about 72% of promised benefits. Since the SS system cannot borrow money either the system will be changed or the lower benefits paid out.
Numerous fixes are being considered to fill the future gap including slowly ratcheting up the benefit eligibility age, changing the benefit formula and raising the cap on income subject to SS tax. Projections suggest that the fixes would not need to be severe to bring the program back into balance but will be more a matter of political will to tackle a headline government program.
What clients in their sixties and late fifties need to understand is that the system continues to work as planned, full benefits are solid for the next 20 years without any legislation, nobody has raided the pantry and some changes will likely need to be made to shore up post-2032 benefits.
Paul Norr is a financial planner in Thousand Oaks, Calif., and writes about money and planning. His website is www.paulnorr.com
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