Advisers will need to act to help clients
navigate what is potentially a looming financial crisis
October 19, 2020 By Mary Beth Franklin
The Social Security trust
funds, created to help pay future retirement benefits when payroll tax revenues
alone are no longer sufficient, will run dry sooner than previously predicted
due to the COVID-19 pandemic and
the recession it triggered.
Social Security benefits
are financed primarily through payroll taxes paid by both employers and
employees, so the rash of business closures and historic spike in unemployment
rates will accelerate the projected trust fund depletion by several years. At
that point, Social Security will only collect enough money from payroll tax
revenues to pay about three-quarters of the benefits retirees have been
promised.
What should financial
advisers do with this information? Should they adjust their clients’ retirement
plans by reducing the assumption about the income clients are likely to receive
from Social Security benefits? If so, should they apply the reductions across
the board to all clients or only to younger ones, who are decades away from
retirement? What’s the likelihood that Congress will step in to prevent future
benefit reductions?
InvestmentNews asked
public policy experts, financial planning thought leaders and individual
financial advisers to share their insights, predictions and practical advice on
how advisers can guide clients during these turbulent times.
DETERIORATING FORECASTS
Earlier this year, the
Social Security and Medicare trustees released their annual report, which projected the
combined reserves of the Old Age, Survivor and Disability trust funds would be
depleted in 2035, resulting in across-the-board benefit cuts of about 21%
unless Congress stepped in before then. But that report didn’t reflect the
impact of the COVID-19 pandemic.
In September, the
nonpartisan Congressional Budget Office updated its annual budget outlook for
the entire federal government, factoring in the economic devastation of the
pandemic. CBO estimates federal budget deficits will more than triple to $3.3
trillion this year as a result of emergency stimulus relief and reduced tax
receipts. It predicts the Social Security trust fund
will run dry by 2031, requiring benefit cuts of about 25%
starting 11 years from now.
“In other words, today’s
youngest retirees will face a sharp 25% drop in their benefits when they turn
73,” the Committee for a Responsible Federal Budget said in its analysis of the
CBO budget outlook update.
“Once the current pandemic
ends and the economy is well on its way to recovery, policymakers must turn
their attention to long-term debt and deficit reduction to get the country on
solid fiscal ground,” the CRFB analysis concluded. “This includes action to
secure Social Security and other trust funds headed toward insolvency.”
Despite the looming
financing crisis, Social Security reform is not at the top of anyone’s legislative
priority list, no matter who wins the White House in November or which party
controls the House and Senate.
“Nobody is worrying about
Social Security reform right now,” said Robert Bixby, executive director of the
Concord Coalition, a nonpartisan policy group focused on reducing the federal
deficit and debt.
“The political environment
is so poisonous, nothing is going to happen immediately, no matter who wins,”
Bixby said. Congress will keep kicking the can down the road until it can’t.
Even the AARP, the nation’s
largest advocacy group for older Americans, isn’t counting on Social Security
reform any time soon.
“With more than 200,000
people dead and millions out of work, Social Security reform is not at the top
of my list of priorities,” said David Certner, AARP’s director of legislative
policy. But protecting Social Security remains a top priority of the group’s
members, regardless of political affiliation, he said.
In theory, Social Security
benefit payouts cannot exceed available revenue, which means that if Congress
takes no action before the trust funds are depleted, benefits would be cut
across the board for all beneficiaries. In reality, that is not likely to
happen.
Historically, Congress has
never cut benefits of current beneficiaries or those approaching that status.
Over the next decade, the number of Social Security beneficiaries is expected
to balloon from 63 million today to about 80 million in 2030, when all baby
boomers will be 70 or older.
“The notion that you’re
going to tell those 80 million people that their benefits are going to be cut
seems fanciful to me,” said Webster Phillips, 31-year veteran of the Social
Security Administration and, until his recent retirement, a senior policy
analyst at the National Committee to Preserve Social Security and Medicare. “It
just isn’t going to happen,” Phillips said, pointing to Americans’ increased
reliance on Social Security in the wake of disappearing pensions and
often-inadequate retirement savings.
When faced with the
inevitable exhaustion of the trust fund, Congress will likely borrow money to
continue paying benefits until it can agree how to tackle the longer-term
financing problems, said Jason Fichtner, a renowned Social Security scholar and
fellow at the Bipartisan Policy Center. “Congress is more likely to face a debt
crisis than cut Social Security checks,” he said.
However, borrowing money
from general revenue threatens to break the traditional link between workers’
payroll tax contributions and their earned Social Security benefit. That could
undermine the program’s financial independence, forcing it to compete with
other national spending priorities for limited federal resources in the future.
Longer-term Social Security
reform will likely require higher taxes, future benefit reductions or a
combination of the two. Potential fixes include raising payroll taxes for
higher-income workers; adjusting the benefit formula to further
favor lower-income workers; altering the cost-of-living adjustment formula;
increasing the portion of benefits subject to income taxes; and gradually
raising the age for full retirement benefits to account for longer average life
expectancies.
ADJUSTING ASSUMPTIONS
This year, the estimated
benefit statements the Social Security Administration issues to individuals
include this warning: “Your estimated benefits are based on current law.
Congress has made changes to the law in the past and can do so at any time. The
law governing benefit amounts may change because by 2035, the payroll taxes
collected will be enough to pay only 79% of scheduled benefits.”
“As financial planners, all
we can do is operate under current law and stress-test those assumptions
against possible economic futures,” said Joe Elsasser, president and founder of
Covisum, a financial software company specializing in retirement planning and
Social Security. “We create a plan based on today, but if that changes
tomorrow, we analyze whether that plan still works.”
Elsasser suggested that
advisers calculate the optimum Social Security claiming strategy under current
law, stress-test it in the context of a client’s overall financial plan and
continue to analyze the situation each year as a potential Social Security
funding crisis approaches.
William Meyer, president of
Social Security Solutions, a financial software company specializing in
optimizing Social Security claiming decisions and tax-efficient income
strategies, suggests that financial advisers assume full Social Security
benefits for clients age 50 or older, but said advisers may want to discount
benefits for younger clients.
“Social Security is so
important to financial planning,” Meyer said. “It has to change, but I don’t
see it going away.”
Mark Howe, director of
financial planning at Frontier Wealth Management in Kansas City, Missouri,
reduces Social Security benefits by 25% when he’s doing plans for clients age
50 and younger.
“Those clients are also
very skeptical about Social Security being around for them — right or wrong —
especially among higher-net-worth and higher-income earners,” Howe said.
Kerrie Debbs of Main Street
Financial Solutions in Cary, North Carolina, said she educates her clients
about the possibility of reduced Social Security income in the future as a
result of benefit reductions, tax creep or increased Medicare premiums that are
deducted from Social Security benefits. “We show them that in order to minimize
or mitigate taxes on Social Security and all income in the future, they should
use tax-free vehicles such as Roth IRA conversions early and often,” she said.
CONVERSION ANALYSIS
Meyer agreed. “In a low-tax
environment with no required minimum distributions this year, the opportunity
to add Roth conversions makes a lot of sense.
“But Roth conversions can
be overdone if advisers don’t pay attention to tax brackets and income
thresholds that can trigger Medicare surcharges,” Meyer said, noting that his
company’s Income Solver software helps advisers analyze whether conversions
make sense.
Jason Lampe of Lampe
Financial in Denver said he uses Right Capital financial planning software to
show clients what their retirement plan looks like with full Social Security
benefits and if benefits were reduced by 21%. For some clients, it can mean the
difference between a successful retirement plan and a failed one. Lampe then
discusses other options to rescue retirement plans, such as working longer,
saving more, cutting spending and delaying Social Security.
Wade Pfau, director of the
Retirement Income Certified Professional designation program at the American
College of Financial Services, agreed that advisers can’t do much more than use
current law to make assumptions about future benefits, including the
possibility of reductions starting in the 2030s.
“But cutting benefit
projections in a retirement income plan is a separate argument from when you claim benefits,” Pfau
said. “With interest rates at historic lows, the case for delaying benefits is
even stronger today.”
Social Security benefits
increase by 8% per year for every year an individual postpones claiming beyond
full retirement age up to age 70. Retirement benefits are available as early as
age 62, but they are reduced by 25% to 30%, depending on birth year.
Concerned about the
long-term financing of the program, some people contend that it is better to
claim benefits as soon as possible. But Pfau argues that in the unlikely event
benefits were cut across the board if the trust funds were exhausted,
everyone’s benefits would be reduced, including those who claimed smaller
benefits early.
“It’s really about
following the optimal course of action today but preserving the flexibility to
change it as we get better information,” Elsasser said. “At this point, it
doesn’t make sense to choose a Social Security strategy based on a foggy
future.”
https://www.investmentnews.com/social-security-cuts-retirement-198279
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