How The Latest Report On Social Security’s Solvency Changes Your Retirement Plan

Retirement

Each year the trustees of Social Security issue a report on Social Security’s financial condition to Congress and the public. The 2019 report came out a few weeks ago, and you can find the 2019 report here.

The report sparks and lot of headlines and discussion about the fate of the program and those who depend on it. After a few days the discussion ends, and people move on to other topics.

This year’s report seemed to spark a little more discussion and concern. Unfortunately, the conclusions many people reached are wrong. You can’t depend on Congress to take action, but most people can depend on some amount of Social Security retirement benefits. You also probably need to make some changes in your retirement plan.

Social Security has two trust funds. The important trust fund for most of us is the Old-Age and Survivors Insurance trust fund (OASDI). This is the one that covers retirement and survivor’s benefits. There’s another trust fund for disability benefits.

Every year the key headline for the media is the latest estimate of the year the OASDI is projected to drain its reserves, which usually is referred to as Social Security “running out of money” or “going broke.” This year’s estimate for the life of OASDI’s reserves is the same as it was last year. The OASDI trust fund is estimated to be depleted in 2034. That’s only 15 years away.

The annual cost of the program is expected to exceed all its income in 2020 for the first time since 1982. The cost is expected to exceed income every year for the next 75 years. (Each year the projections are made only for the next 75 years.) The cost of the program has exceeded its non-interest income since 2010.

While those are the main points, there’s a lot of misunderstanding about exactly what they mean and how people should respond. Since the report was issued, I’ve talked to people of different ages who believe that their and everyone else’s Social Security benefits will end in 2034.

That’s not what the report says.

First, it’s important to note that the projections are based on a lot of estimates of economic growth, salary levels, tax collections, inflation, and other factors. If the estimates are too pessimistic, the trust fund will last longer.

Second, the report says that the trust fund, or reserves, will be depleted by 2034. You might recall that for decades Social Security taxes exceeded the benefits paid. The trust fund lent that excess money to the Treasury, which gave the trust fund special bonds. The trust fund will be depleted when all those bonds are cashed in.

Third, and most importantly, each year the program will continue to receive Social Security taxes indefinitely. Those taxes will help pay benefits each month.

The trustees estimate that these taxes will be sufficient to pay 77% of the promised OASDI benefits for at least the next 75 years.

The bottom line is that Social Security won’t die. But changes will be made, and your retirement plan should have some flexibility so you can respond to the most likely changes if they are made.

People already receiving Social Security retirement benefits are likely to be sheltered for the most part. The exceptions probably will be beneficiaries Congress considers to be affluent. It’s possible that beneficiaries above a certain income level will face an outright benefit reduction, known as means-testing. Some financial advisors say that anyone with a retirement income of $250,000 or higher should assume their Social Security benefits will be eliminated. Congress frequently uses a benchmark near that level to define the wealthy.

That’s probably the most drastic of the potential changes, but it wouldn’t surprise me if Congress imposes this kind of means-testing on people already receiving benefits. The longer Congress waits to act, the more likely it is the changes will affect those in or near retirement.

There’s a higher probability that the formula for paying income taxes on Social Security benefits will be adjusted so that higher-income beneficiaries have more of their benefits taxed. Instead of a maximum of 85% of benefits being included in gross income, 100% of benefits will be included in gross income at some high income levels.

Congress might even impose a special tax rate or surtax on Social Security benefits of higher-income beneficiaries that essentially reduces or eliminates their benefits.

To be safe, I’d assume that if your income is high enough for some of your Social Security benefits to be taxed today, your future plans should assume 100% of the benefits will be included in gross income and subject to income taxes starting around 2034.

I think there’s also a high probability there will be a reduction in the annual cost of living allowance (COLA). The COLA already is less than general inflation. The trustees’ report assumes benefits grow one percentage point less than general inflation each year.

Congress easily could adjust the COLA formula (as it did in the 2017 tax law for many other inflation adjustments) so that benefits increase less each year than they do under the current formula. This change likely would apply to all beneficiaries, and I think it would take effect immediately after it is enacted.

People who are years from retirement now are likely to pay higher payroll taxes during the rest of their working years. They’re also likely to see the benefit formula adjusted so that they receive lower retirement benefits than under the current formula.

The bottom line is that Social Security retirement benefits aren’t going away. But after 2034 the system can pay only about 77% of promised benefits, if the trustees’ assumptions are accurate.

The bulk of that gap will be closed by affluent retirees. Affluent retirees receiving benefits at the time changes are made could face some combination of lower benefits and higher taxes. Future retirees should expect a combination of higher taxes during their working years and lower retirement benefits, with the changes affecting higher income people more than others. All current and future Social Security beneficiaries are likely to receive lower COLAs.

Because of Social Security’s financial condition, you need a cushion in your retirement plan. Most people should assume they’ll incur a combination of lower benefits and higher taxes equal to at least 20% of their estimated or current Social Security benefits. The higher your income and net worth, the higher that percentage should be.

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