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How to Fix Social Security

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Should we be worried about the solvency of Social Security? Joining me to discuss that topic is Tim Steffen. He is director of advanced planning for Baird.

Tim, thank you so much for being here.

Tim Steffen: Thanks, Christine.

Benz: Tim, the Trustees, Social Security Trustees, released their most recent report. Can you, kind of, sum it up?

Steffen: Sure. So, the Board of Trustees--every year they issue a report that, kind of, gives the status of what happened over the last year and what to look forward to. In this year's report, it was actually a little bit of good news. A year ago, we were anticipating, or they were anticipating that 2018 would be the first year of deficits for the first time in quite a while. As it turned out, operations were a little bit better than they expected in 2018. So, they actually ran a little bit of a surplus, which is good news. Still not great news long-term, but, for the short term, 2018 ended up being a little bit better than what they thought it would be. So, that's good.

Benz: The Trustees did propose some fixes, and certainly people who have been paying attention to this issue have heard some of them. Let's talk about some of the things that could shore up Social Security long-term.

Steffen: So, the plan right now is that--if things go as they continue to forecast--is that 2035 is the year when the fund would completely run out of money and then benefits would just be paid based on ongoing tax revenue that they collect from those who continue to work. What the Board of Trustees has said is that to shore up the fund for this 75-year window--which is their long-range forecast, that's what they like to target--is you can do one of three things. Any one of these would fill it up for the next 75 years. And that is: Either increase the payroll tax by 2.7%. So, you think about that 6.2% that we all pay into on the FICA tax in our wages--increase that by 2.7%. That can be paid either by the employee or the employer, or some combination, but it would go up by 2.7%. You could also cut benefit payments to everybody who is receiving them now and would receive in the future by 17%. Or the third option they said is if we're going to leave current retirees alone and just cut benefits for future retirees, cut them by 20%. Any one of those three things would allow the trust fund to meet its 75-year target of solvency. Of course, they say you could also combine those and maybe lessen the impact on any one of them. But if you just were going to do one thing; it'd be one of those three perhaps.

Benz: It seems like another fix I sometimes hear about is lifting the cap on wages that are subject to Social Security tax. That's an option, too, right?

Steffen: Yeah, there's a lot of options out there. This is not a one-solution problem here. There are a lot of things they can consider. And in fact, one of the things the Trustees do is they look at all these proposals that people have given out there: changing inflation factors, changing tax rates, investing in private accounts. All these different strategies that they've come up with, and they give a forecast of how long they think some of those things might actually improve the fund. The reality is most of them don't make a lot of impact. Many of them are single years, three- to five-year impact. Some of the larger ones would be like really increasing the tax base. So, if you were to, for example, remove the cap on wages--right now, it's roughly $125,000 or so that's subject to the 6.2% tax. If you were to eliminate that cap, that would add decades to the fund. It would also be a significant tax increase on everybody who is over that threshold. So, there's some things to weigh there. There's a lot of options. No one option is going to be enough to change everything. It's going to take a combination of things most likely.

Benz: So, these are the recommendations from the Trustees, but ultimately, congressional action would be required to make a change. So, let's talk about that. It seems like we are in the midst of major gridlock in Washington. So, is real action on Social Security even realistic?

Steffen: Yeah, we've been seeing this gridlock for a long time. It seems like we need almost one-party control to really see any kind of progress. Whether you like that progress or not, that's the only time we really see anything significant done. Yeah, it's going to take something like that. If you think about, kind of, how in human nature we all work best with deadlines, right? The last time there was a major Social Security forum back in 1983, there were projections that said Social Security was within months of running out of money, not the years or decades we have right now, which is still an urgency, but even within months. It may be until we get something along those lines to get closer to it. The fact that the Trustees report actually had some good news in it this year, probably slowed a little bit of that urgency, which maybe unfortunate. But as we get closer to these deadlines, hopefully something will happen. Unfortunately, the longer we wait, or the longer congress waits, the more draconian the fixes are going to have to be--bigger tax increases or bigger cuts.

Benz: So, let's talk about how individuals should approach this. I talk to even very well-informed people who sometimes say, "I'm looking at the information about when Social Security is going to run into problems; I'm taking my benefit early; I don't care what you say about delaying and the benefits of delaying." How should people approach this?

Steffen: Yeah, the old bird in the hand type thing, right?

Benz: Exactly.

Steffen: Yeah. And we hear the same thing. A lot of people are very concerned about it. The one thing I tell people is that even if the trust fund ran out of money today, they would again still be able to pay benefits, as we said, for the people who continue to work. It'd be about a 20% cut. So, they could still fund about 80% of the promised benefits. But I think most people understand that at some point along the line something will be done to fix this. We may not like the fix. It may be an expensive fix, and it may involve a combination of tax increases and cutting benefits. But something is going to happen. So, we still tell people that unless you have the worst-case scenario about Social Security, you're still likely better off waiting to start benefits. The 8% per year that they give you for waiting from age 62 to age 70, roughly, it's about 8% a year, that's a pretty impressive return they can give you and that's a nice benefit. So, if you can hold out, you're probably off waiting for that. We do see a lot of families, kind of, hedging their bets a little bit. We'll see maybe one spouse take benefits at full retirement age while another spouse delays and waits till later in life just to kind of take a little bit now and leave a little bit for later. We tell them again--to your longer-term financial benefit if you can wait, but I understand people's urgency and want to take money now, too.

Benz: So, you mentioned that 8% return. One comment I sometimes hear is, "Well, I think I can invest better than that." What's your response to that?

Steffen: You know, in a year like 2019 where we are seeing double-digit returns only a third a way through the year, I understand that. But last year it was a different story. So, yes, 8% on any one given year, you might be able to beat that. To do it over a longer-term period, like the eight-year window from 62 to 70, that's a hard thing to do, over multiple years like they have to consistently get that 8% rate of return. So, we still say that 8% is pretty significant and you want to let them pay that for a guaranteed ...

Benz: And it's guaranteed. It's impossible to beat.

Steffen: I mean, it's guaranteed as long as they don't change the law, which I guess is always a possibility. But for now, that's as guaranteed as you can get.

Benz: Finally, Tim, I sometimes hear from younger investors who say, "I'm not planning on any Social Security. I don't think it'll be there for me." That doesn't seem realistic either, does it?

Steffen: It doesn't. I've been doing this for a long time, and some of those people who I used to talk to who were the younger ones who are now getting close to taking it, those pessimists who didn't think they were going to get it, are now starting to plan how they are going to get it. So, yes, it's easier to sit back and say, "I'm never going to get it. I've never going to get it." And frankly, if you want to plan your retirement on not getting it and just treat Social Security as a bonus, that's fine. That's probably ultra conservative. But I understand why people do that. I think realistically it's going to be there for the long haul.

Benz: Okay, Tim. Always great to get your perspective. Thank you so much for being here.

Steffen: Yet bet, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.