Should You Be Worried About the Health of Social Security?

Christine Benz: Hi, I’m Christine Benz from Morningstar. Social Security is a bedrock of the retirement system in the U.S., but concerns about its financial health have been looming for some time. Joining me to discuss that topic is Social Security expert Mary Beth Franklin. She is also a contributing columnist at Investment News.

Mary Beth, thank you so much for being here.

Mary Beth Franklin: Thank you, Christine. I’m always thrilled to talk about my favorite topic.

The Social Security Administration Release

Benz: Well, I know, and you are so great on this topic. I’d like to start with this recent release from the Social Security Board of Trustees. It indicated that the combined trust fund for Social Security is set to be depleted in 2034. Can you explain what that means and the implications for Social Security recipients?

Franklin: Sure. Every year the Social Security trustees are required to issue basically a health report on the financing of Social Security. And as we’ve known for a very long time, Congress needs to make changes to ensure the long life of Social Security. And each year, they issue a report we’re getting closer and closer to what they would call the trust fund depletion date. Now, does that mean Social Security is going bankrupt? No, it doesn’t. Because we all pay these payroll FICA taxes whenever we get paid on the job, and those FICA taxes are what fund Social Security. And for much of the last few decades that was sufficient money to pay all promised benefits. But around 2010, it wasn’t enough, and we had to start tapping into this excess money that we call the trust funds. And now that we are tapping into the trust funds, they’re getting smaller and smaller. And if Congress did nothing between now and about 2034, there would be enough money from ongoing payroll taxes to pay about 80% of promised benefits. But frankly, you, me, and everybody else in the country will not be satisfied with 80% of promised benefits. We want the full boatload. So, Congress needs to take action by doing things like either raising taxes or refining or reforming benefits in a way that Social Security will be there for all of us in the future.

FICA Tax and Benefit Fears

Benz: That’s helpful. I want to talk about how people should respond to this, because I think hearing this news, people who are getting close to Social Security age might think, “Well, I’m going to take the money and run. I’m going to claim, even if it’s early, even if I’ll have to take a haircut in my benefits.” Is that a wise way to approach it?

Franklin: I personally don’t think it’s a wise way to approach it because you would basically be claiming Social Security benefits out of fear of the unknown, essentially. Generally, Social Security benefits, if you wait until your full retirement age to claim them, which could be anywhere between 66 and 67 depending on your birth year, you get full benefits that you have worked so hard for and paid so much for in the form of FICA taxes. Now, you can claim benefits as early as age 62, and for some people, that’s an appropriate decision. They need the money, they can’t work anymore, they’re ill, they need that money. Go ahead and claim it.

But for someone who says I’m going to claim my benefits early because I’m afraid Social Security will run out of money, here’s what would happen. Let’s say your full retirement age is 67. You claim five years early at 62 because you’re scared. Now you’re going to get a 30% haircut for the rest of your life on those monthly Social Security benefits. And now, let’s imagine the worst-case scenario happens and Congress doesn’t act in time and all Social Security benefits have to take a 20% haircut. That’s going to be on top of the 30% haircut you already took by claiming early. I don’t think that’s smart. And if history is any judge, Congress very seldom would cut a benefit for current or near retirees who have been factoring the importance of guaranteed income of Social Security into their monthly retirement income plan. Now, younger people, they may have to be more conservative. And worst-case scenario, if someone was going to be maybe 55 or younger by 2034, then their financial advisor might say, “Let’s just look what would happen to your Social Security plan if benefits were cut by 20%.” Now, remember, that’s not cutting your total retirement income by 20%, because you probably have a 401(k), an IRA, maybe a pension or other investments. It would be trimming the Social Security part of that retirement income plan by 20%.

SSA and Benefit Cuts

Benz: I just want to back up, Mary Beth. For people who are getting close to retirement, is there any sort of age cohort that’s officially kind of in the clear where if I go on Social Security’s website and see what my promised benefits are that I indeed will get those benefits if I’m past, say, age 55? Or is it not really that clear-cut?

Franklin: It’s not that clear-cut, because Social Security can only pay benefits from money it has on hand. And in theory, if those reserve trust funds run dry and there’s only enough tax revenue, FICA tax revenue, coming in to pay benefits and there’s a 20% shortfall, it would apply to everybody. In reality, there are currently more than 66 million people receiving Social Security benefits. In the next decade, it’s probably going to be 70 million people plus. Does Congress really want to cut the benefits of more than 70 million Americans, many of whom rely on Social Security for 50% or more of their retirement income? I don’t think so.

So, the reality of people who would be receiving Social Security benefits a decade from now, or who would be close to claiming Social Security retirement benefits a decade from now, I think it’s unlikely those benefits would be cut. Congress would be doing something for them. The chances of benefits for future retirees beyond that could be affected, absolutely. Maybe there would be a gradual increase in the full retirement age from 67 to, say, maybe 69 or 70. But often those kinds of changes are phased in over decades.

Benz: You mentioned for younger age people that they might factor in, say, a 20% potential benefits cut. Is means testing a realistic possibility for folks as well and should higher-income younger people be a little bit more worried and a little bit more conservative in their Social Security planning?

Franklin: Anything is possible. I tell people that as a former Capitol Hill reporter who covered the original Social Security reform legislation in the 1980s, I used to have a really good feel of what Congress was likely to do. Well, now that crystal ball looks a bit more like a snow globe. It’s pretty fuzzy. Anything could happen. Generally, because we have such divided politics on Capitol Hill, and we have no clear leadership coming from the White House for a solution, my feeling is we’re going to have to go out to a third party, maybe some sort of bipartisan commission, to come up with a solution that will balance the needs of current retirees and workers who will be future retirees.

That means there may have to be some changes on the benefits side for future workers. Maybe today’s 2-year-olds might have to wait till 70 to claim benefits. But hey, they’re probably going to live till 120. They’ll get used to it. And while current retirees at the time of depletion may be set as far as the way the benefit formula is structured, they may face things like 100% of their Social Security benefits might be taxed compared to 80% under current law. But they may change the threshold for taxing those benefits. They’ve been in effect for 40 years at very low income thresholds—$25,000 if you’re single, $32,000 if you’re married. Maybe those thresholds get increased to $50,000 or $100,000. So, there will be changes in place.

My feeling is, just like in 1983, the solution requires that both political parties are equally unhappy. That means the Democrats who hate benefit cuts might have to accept changes like a higher full retirement age. The Republicans who hate tax increases may have to accept changes that will lead to higher revenues on some people, particularly higher-income retirees. We just don’t know. But it always is a good idea to be prepared with the Plan B.

Benz: Well, Mary Beth, no one else knows this area quite as well as you do. Thank you so much for being with us today.

Franklin: Thank you for giving me the opportunity. And I want people to remember how important Social Security benefits are. For so many people who no longer have a pension from a private employer, the idea of having guaranteed income for the rest of your life that’s inflation-adjusted and it lasts as long as you do no matter how long you live is critical. And I think we, as citizens of the United States, should make sure our lawmakers understand how critical it is to us and we demand a solution.

Benz: It’s such a great point, Mary Beth. Thank you so much for being here.

Franklin: Thanks, Christine.

Benz: Thanks for watching. I’m Christine Benz from Morningstar.