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Investing Specialists

How Worried Should We Be About Social Security?

We put that question to Social Security and retirement expert Mary Beth Franklin.

Social Security supplies a huge percentage of income for many retirees; for some retirees, it's their sole source of income. 

But should retirees and pre-retirees--as well as younger workers--brace themselves for changes to the program? In a recent interview on Morningstar's podcast, "The Long View," co-hosts Jeffrey Ptak and Christine Benz delved into the health of Social Security with retirement expert Mary Beth Franklin of InvestmentNews. Among other topics, Franklin assessed the health of the Old-Age, Survivors, and Disability Insurance Trust Fund, which provides part of the funding for Social Security and is scheduled to run out within 10 to 15 years unless Congress takes action to fortify it. She also discussed possible changes to how Social Security works and how such adjustments should affect claiming strategies, if at all. 

Jeffrey Ptak: The latest report from the Social Security trustees indicates that the Social Security Trust Fund will run out by 2035 if no action is taken to shore it up, and that doesn't even take the pandemic into account. The question is, how concerned should we be about the health of Social Security overall?

Mary Beth Franklin: That's a great subject to bring up, Jeff, and you are correct. The latest Social Security trustees report was compiled before the pandemic. It essentially said the combined Old-Age, Survivors, and Disability Trust Fund would run dry around 2035, which is the same estimate as the previous year. There are other think tanks that watch this closely, and they said, "No, probably it's going to be a lot sooner than that, possibly by the end of this decade, 2029."

Why is that? Recession has a severe impact on the Social Security Trust Fund for four reasons. One, those payroll taxes--that we pay with every paycheck--is what funds Social Security. The money is specifically earmarked to fund Social Security. When you have 40 million people out of work, they and their employers are not paying FICA taxes, so, less money is going into the trust fund. Also, when you have a severe recession, you may have many people ... 62, 63, 64, who may have lost their jobs, and they decide they need to claim their Social Security benefits earlier than they had planned. So, more money is coming out of the revenues as well. And higher-income retirees pay taxes on a portion of their Social Security benefits. Maybe if their income is down because they lost a job or their investments are down, they might not pay any taxes on their Social Security benefits. And then, the final step, the Federal Reserve had stepped in to basically lower interest rates to zero to keep all the credit markets running, but that also means the securities where the Social Security Trust Fund reserves are invested are earning less money. So, it's a quadruple whammy, really, against the Social Security Trust Fund. The problem, however, is still the same: That the way to fix it is either to get more money into the system or take less money out in the form of restructuring or reducing benefits or a combination of the two.

The thing about the Social Security Trust Fund is, since about 2010, our last recession, there was enough money prior to that from just ongoing FICA taxes to pay all the needed benefits. Around 2010, when we had a recession, we needed the money from the Social Security FICA taxes and money from the interest that was being earned on these securities to pay the benefits. But we weren't actually tapping the noninterest reserves. We're expected to start tapping that excess money that's been built up over the last 30 years, next year. And by 2035, if Congress does nothing and the reserves are depleted, there would be enough money from ongoing FICA taxes to pay about 79% of promised benefits.

Now, none of us is going to be satisfied with 79% of promised benefits. It would essentially mean a 21% across the board cut in benefits for everybody who is getting benefits. Now, nobody wants to see that happen. And I doubt Congress wants to see that happen because they know that old people who receive Social Security benefits tend to vote in higher numbers than the rest of the population. When this happened back in 1983, and I will add that I was a very young reporter for United Press International back in 1983, and I covered the Social Security reform legislation back then, and what they decided was, "Let's institute some changes, like let's gradually increase the full retirement age, which at the time was 65 to 67." There was a huge outcry, "Oh, this is horrible; you can't change it." Well, that was nearly 40 years ago, and that part of the legislation has not been fully implemented yet, because people born in 1960 or later, whose full retirement age is 67, that doesn't kick in until 2027. Congress gave us more than 40 years to get used to changes like a higher full retirement age and taxing some Social Security benefits for the first time and a few other changes like that.

The sooner Congress steps in to make needed changes, the easier it will be for the population to adapt. And I like to be the optimist. If you had asked me in January 2020, "Could Congress get together to agree on anything?" I would have said, "No way." But as a result of the pandemic and the crisis--we saw that in a crisis, our lawmakers actually can work together. And that does give me hope that Congress will address the shortfall of the Social Security reserves as soon as it gets the COVID problem under its belt, because it has demonstrated during this recession how incredibly valuable the guaranteed income of Social Security is and why it's imperative that they fix it for current and future retirees.

Christine Benz: I have two follow-up questions on that. One, of the adjustments on the table related to Social Security--so for example, lifting the cap on Social Security tax, changing the age, means testing, other things--which of those do you favor? And then, also, which combination of those fixes do you think is most politically tenable at this juncture?

Franklin: Those are great questions. Again, I'm a proponent of phasing in changes over a long period of time. And I've heard a lot of talk, and it's controversial, of gradually raising the full retirement age, which is currently set to go to 67 to maybe 69 or 70. And people are aghast at that thought. But I'm saying for today's 2-year-olds, you know, frankly, they're probably going to live to 120. They'll get used to it. When you look at when Social Security was created in 1935, 65 was the full retirement age. In 2020, with the incredible increases in longevity we've seen for the average American--the average 65-year-old woman is going to live till 86; the average 65-year-old man is going to live till 84; and half of Americans are going to live longer than that--and yet, the full retirement age for Social Security benefit is only one year longer than it was more than 80 years ago, and it will go up one more year.

I think one could argue to gradually increase the full retirement age to 69 or even 70 with a very, very long lead-in time. Others would argue it's very important to keep the early retirement date of 62 because there are people in physically challenging jobs--construction, retail, restaurants, whatever--that physically just can't go beyond 62 to claim benefits. So, it's important to have that flexibility. Also, back during the 1983 Social Security reforms, the bipartisan commission on Social Security reform said as long as 90% of U.S. wages were taxed for FICA purposes, Social Security would be financially fine in perpetuity beyond the usual 75-year look-ahead that it used for its analysis.

The problem is, so many people make so much more than the taxable wage base right now, which in 2020 is $137,700. If you make up to that amount, all your wages are taxed for Social Security purposes--6.2% on your side and your employer side. People who make more than that do not pay any additional FICA taxes for Social Security. They pay a very small portion, 1.4% or 1.5%, they and their employers, for the Medicare portion. So, as a result of this big gap of earnings, only about 83% of U.S. wages are being taxed for FICA purposes now, rather than the requisite 90%. If we gradually let that taxable wage base float up to 90%, and we're probably talking about $250,000 a year of wages, and then index for inflation after that, that--together with raising the full retirement age--solves the lion's share of the problem. Are they politically feasible? Well, basically, everybody is going to have to be unhappy in order to work a compromise. Generally, Democrats hate benefit cuts, and they consider raising the full retirement age a benefit cut. Generally, the Republicans hate tax increases. So, like in 1983, we'll probably have to do a little bit of both and make everyone equally unhappy.

Ptak: We often hear from retirees who say they don't want to delay because they're fearful. Notwithstanding your optimism, they're fearful about how the program will change between now and when they do file. How do you think some of the uncertainty that we've been talking about, how should this affect individuals' filing decisions, if at all?

Franklin: Well, it's a legitimate concern for some people. But if you're saying, "I'm going to grab my benefit at 62 because I'm going to get mine while I can and I'm afraid it's not going to be there," it's a bit like watching the stock market drop 35% in March and saying, "I'm going to cash out right now," in that all you have guaranteed is you have locked in your loss. But if it makes you feel better, maybe that's what you need to do. I would say to people who are thinking about claiming before their full retirement age, just be aware that if you do, your benefits may be permanently reduced because you claimed early. If you continue to have earnings from a job, this is not pension, noninvestment, but actual wages from a job and you claim before your full retirement age, you may lose some or all of those Social Security benefits, at least temporarily, because you're making too much money. And if you're married and you die, you may be leaving your surviving spouse with the smaller survivor benefits. Those are all the consequences of claiming before your full retirement age.

I don't have a crystal ball. I cannot tell you what Congress is going to do. In fact, I used to say that my crystal ball looks more like a snow globe at this point. I don't think anybody can tell you what Congress will do. But it's highly unusual for Congress to change benefits retroactively. I think you may see changes to some high-income beneficiaries. There is talk that they may change the benefit formula so lower-income people get a bigger benefit--and frankly, that's the way the system is designed already--and that higher-income people get less. I think it's very important that people, regardless of their income, get a Social Security benefit that they have paid for, because this is an earned benefit. I think if you turn it more into an income transfer, it becomes welfare for retirees and then, frankly, it loses its political clout.

I can't tell you what's going to happen. If it makes you sleep better, go ahead and take it, but realize your benefits are going to be smaller. If you can wait till your full retirement age, do that if you can, because even if you're still working, the earnings restrictions go away, meaning you can continue to work and make as much money as you want and it won't affect your benefits. But for those people who have the luxury of being able to wait up until age 70--I say luxury in the sense of what are you going to do for money in between, maybe you're still working, that's great, solves the problem, or maybe you have other investments you can tap, another good solution, and you're healthy enough to be around--then waiting until 70 is even more valuable in today's zero-interest-rate environment where the government is offering you 8% per year for every year you postpone your benefits beyond full retirement age up till age 70, and you can't get that anyplace else.

Benz: You just referenced the interplay between portfolio withdrawals and Social Security filing. And this was certainly top of mind during the first quarter when markets were sliding. So, in a situation like that, even though we often hear it's often better to pull from your portfolio sooner if it means you can delay filing, does that get flipped on its head, do you think, in certain environments if the only choice is to pull from a portfolio that has dramatically declined?

Franklin: Well, I think you'd have to look at the portfolio makeup there. Realistically, when you see these analyses, it sort of makes the assumption that the whole portfolio is in equities, and let's say, your portfolio has dropped 35%, that also sort of makes the assumption you are 100% in equities. Most retirees aren't in that situation. Did they have fixed income? Did they have bonds? Is there something they can draw from that they're not taking from the equity side of their portfolio if it's down? If that's not the case and they don't want to tap their investment portfolio and they're not subject to required minimum distributions in their retirement account, well, then it could make sense for some people to turn on those Social Security benefits instead.

The important thing is, these are just rules of thumb, and you have to look at Social Security as a piece of a bigger retirement income puzzle, and you're looking at the makeup of the other pieces of that puzzle in terms of specific investments and other assets and the person's health as well.

Ptak: What about younger investors or people who advise them? First, what do you say to the ones who say they're not planning on any Social Security at all?

Franklin: I do hear that a lot. I have two sons in their 30s. So, they are of that peer group. I tell them that it will be there for you. You pay your FICA taxes in; you will get a Social Security benefit in the future. It may not look exactly like the benefit your parents are getting. One of the big questions when we get to Social Security reform is, "How will the benefit formula be structured?" If, for example, they raise the taxable wage base that I was talking about earlier, so you're paying taxes on your first $200,000 instead of your first $137,000--presumably, that would also mean you would get a bigger Social Security benefit in the future. However, if lawmakers also tweak the benefit formula that wealthier workers are paying more into the system but getting less out in benefits in the future, well, then the onus is going to be more on people for their individual savings.

I think we're going to see much more engagement at the employer level on not just the retirement savings that have become so critical in what has turned out to be a very fragile safety network. But I think you're going to see more emphasis at the employer sponsor level of things like financial literacy, financial wellness, debt management, because I think for so many, particularly younger workers, their biggest issue during the pandemic was not so much retirement savings as emergency funds and getting out of debt. And frankly, all Americans need to learn these lessons that, yes, it's very important to save the future for your retirement, preferably doing it out of your paycheck each week or month, however you're paid, and just leaving that untouched, but you can't ignore your current needs, and putting an emergency expense on the credit card is probably not your best solution.