All those dollars….
Social Security is not bringing in enough money to remain solvent in the long term. Worse, with the job picture not improving significantly the last few years (despite job ‘growth’ the last few years, there have been several months, December 2013 included, where job ‘growth’ didn’t even keep up with the rate of population turning 18, so there’s a growing job ‘gap.’ The only reasons why the job picture appears to be improving are people giving up looking for work, reflected in labor participation rates for sub-60 year olds plummeting, and individuals retiring and taking social security, which means fewer people paying into social security while more people receiving benefits). You need to be prepared for the future!
Let’s take a quick look at their proposals to help fix it: http://www.ssa.gov/oact/solvency/provisions/index.html
- A. Cost of Living Adjustment formula changes. (COLA changes)
This one features prominently in my own retirement calculator. I assume that COLA -1% will go in because it’s really a very minor change and “kicks the can” down the road about 10 years, which let’s be honest, is about all the political climate allows.
The chained COLA receives a lot of press, but it doesn’t really save enough money to be considered a significant change and I’d not make any assumptions about it. If you prepare for the COLA -1%, you’ll be covered for this and will be better off financially if this option is taken (at least until SS trust fund runs out).
- B. PIA changes: None of these options make a significant impact upon SS’s Long Term solvency so I’m going to ignore how these impact your retirement planning.
- C. Retirement Age:
There are two interesting changes here that could affect how you plan. The first one, the scary one, is c2.1, increasing the minimum age of benefits. I read somewhere recently that upwards of half of all individuals take social security benefits as soon as they can, so increasing this age could affect upwards of half of all Americans. Further, with companies being more and more likely to eliminate older workers from their workforce, and long term unemployment being a fact that the 60+ crowd is having to deal with, this change may mean you’ll need a much more robust emergency fund as you approach your 60’s.
Emergency funds function two ways for those in or approaching retirement: They shelter you from unemployment (most adults plan to work at least part time in retirement) and also shelter you from having to withdraw money from your retirement portfolio when the markets are down. I’ve seen a few different places that retirees or near retirees will want to have a year or more of expenses in cash (or near cash equivalents) to ride out these bumps.
If the change to minimum retirement age were to go through, which provided people currently aged 62, 63 and 64 with a fall back if they lost a job, now you may need 2 years equivalent of retirement savings to make it through the long term retirement that many near retirees face. The would probably not require you to make too many changes to your retirement savings plan right now as I believe most readers are planning on working into their 60’s already. As you approached retirement, you’d more actively move a portion of your savings to cash early.
The second one is c2.5, which adds to the mix that normal retirement age (NRA) could be pushed back to 70. For our youngest readers, this is pointed squarely at you. I imagine that many individuals count social security payments at NRA because those are the values that Social Security makes available to you for planning purposes. Finding out you wouldn’t receive that level of payout until 70 instead of 67 could force you to either delay retirement until 70 where you would be receiving your Social security, or force you to save the difference. Adjusting to either of these changes could be difficult, because do you WANT to work 3 more years? I doubt it. However, those 3 years worth of social security are nothing to sneeze at, arguably worth another entire year’s worth of salary being saved. If you’re under age 40, that might mean saving an extra 1 – 2%/year to prepare for it.
- D. Benefits to family members: It doesn’t significantly impact long term viability of the social security trust fund and I doubt anyone’s planning on being in the situation it describes, so we’ll skip it.
- E. Payroll Tax Changes:
This is a scary one for many folks, myself included. An extra 3% tax, even if it’s ostensibly ‘shared’ between my employer, and me is still 3% compensation I’m not going to see. With average American’s not seeing a 3% payroll adjustment in any of the last few years, this could put a significant crimp in your pay for a few years. That said, new taxes give politicians a severe case of “never getting elected again” blues, so I doubt it’ll change in 2014. Even with a lame duck president, it’ll still be difficult for career congressmen to survive the “you raised taxes on middle class Americans” chant during the following election cycle.
The step change is interesting, but again, saying you’re going to raises taxes on all Americans by 6%, even if it’s 40 years down the road, will be a tough sell. That said, it does kick the can down the road a fair ways and that way means it’s conceivable to be passed. That said, how do you prepare for it? What adjustments do you make? None that I can tell, other than to assume social security will still be around.
The most conceivable one I see happening is E2.3, which eliminates the limits on income for social security, where social security goes from being a sort of insurance against old age to becoming an income redistribution scheme where individuals of high income explicitly pay for lower income individual’s benefits. This will be a fairly easy sell to voters because the vast majority of cost will fall on high income individuals. Right now, Bill Gates pays in as much to social security as his engineers, despite earning many millions of dollars/year just in dividends. That would change to where he’d pay millions of dollars into social security. The upper middle class would feel the hit as well, but it would still be a much easier sell than actually raising the nominal value of the taxes. E2.5 would let the politicians save face by saying they didn’t raise taxes on middle class Americans and would still plug the hole almost as effectively. Adjusting your retirement strategy to this scenario is just to assume social security will be there, paying its benefit in full. Not much else you can do.
- F. Coverage of Employment/Earnings:
This is a clever move. It basically allows the government to say they are “closing loopholes” in the system to squeeze more money out. For example, right now, employer supplied health insurance costs are exempt from Social Security taxation, and these can provide (easily) 20% or more of the compensation of middle class American families. With these costs added to the way compensation is calculated, then many more middle income Americans would count as upper-middle class in compensation. Say a family of 4 receives $12,000 in Employer health insurance compensation, while earning $40,000/yr in salary. Under the current system, that $12,000 is exempt from SS taxes. In this revision, the employer (or the employer and employee together) would need to cough up an extra $1,488/yr. This is quite literally a tax on the middle class (with no impact on high income individuals), so I see no chance of it passing.
None of the other plans benefit social security, so we’re just going to ignore them.
- G. Investment in Marketable Securities:
This is a difficult topic to really feel what impact it’ll have. Right now, all of your social security dollars are invested in treasury bonds which pay crap in interest. That said, it provides a significant portion of the demand for treasury bonds, keeps their prices high and treasury bond rates relatively low, thus also helping to keep mortgage rates low, car note rates low, etc. Changing this so that they’re shifting $1,000,000,000,000 (1 trillion dollars, or around 40% of the social security trust fund) to equity markets could have a destabilizing effect on treasury rates.
Further, 1 trillion dollars flooding into equities could have a disruptive impact on equities. Norway’s sovereign wealth fund invests in marketable securities, bonds and (to a lesser extent) real estate, and it’s been speculated that that huge pool of cash has disruptive effects when it comes to town looking for investments. Imagine the announcement that Social Security was going to buy a trillion dollars of S&P 500 index fund: Everyone and his cousin would buy up as much stock as they could, wait until social security bought up its amount at exaggerated prices, just to have everyone else sell a portion, take profits and let social security functionally ‘pay’ for wall street traders getting rich.
In theory, after that initial loss of value (I’d venture to say 20% or more of the invested money would be lost within a few months), the markets would probably work normally again and the return on capital would be much better than what treasuries are now paying. That said, even the Social Security Trustees don’t believe the markets will return much more than 6% at best and it won’t really help the the long term financial situation of the trust fund.
So, how would I recommend preparing for this option? Do nothing right now, but if you hear that this does happen, leverage up, buy as much stock as you possibly can, and then sell half of your positions after the trust fund is fully invested, taking your profits. Those gains ought to help cover you for the social security shortfall after the trust fund is depleted.
- H. Taxation of Benefits
This looks believable that social security benefits are treated like ordinary income. It would function as a tax on people with lots of savings or who continue to work in retirement. I’d assume it happens, but it shouldn’t significantly impact your retirement picture if social security represents less than half of your retirement picture. It may be worth revisiting if they do make this change to calculate out what the impact is on you personally; it may mean you need to save more, or move more of your retirement savings into categories that are not taxed as ordinary income (Roth accounts or Municipal bonds).
- I. Individual accounts:
The social security trust fund is largely sustained as an insurance plan against old age by redistributing money from folks who die young to folks who do not die young. Having individual accounts would potentially eliminate that. Also, if the individual accounts allow investment in the equity markets, you end up with the downsides captured above in G again.
- J. Do nothing:
If our government spends the next 20 years doing nothing (not precedent setting after the last few years and their inability to deal with social security or deficit spending or the debt ceiling), then you can expect social security to pay out ¾ of the benefit it does now. That said, if the trust fund did go belly up, I can’t imagine congress allowing the spending cuts to happen. I believe they’d have the general fund make up the difference to avoid having 50 million angry retirees voting for other congressmen who promised to restore their benefits.
Do you see any of the above scenarios directing you to save more because social security won’t be there? No. I honestly believe Social Security will be there in some form for all Americans because the largest voting block in the USA are retirees and politicians will cater to that group at all times.
The most likely changes are removing income caps on taxation (suggestion E, above) and changing the way cost of living increases are calculated (A, above). The first one would leave you anticipating 100% of your currently predicted social security benefit and the second would leave you most of it.
Medicare, on the other hand, is a wickedly complicated beast that I don’t know what they’re going to do about it or how you can best prepare for that can of worms to be fixed.
Disclaimer: I do not have a crystal ball and may not be able to guess the future of this cornerstone government program. That said, these make sense in my own mind.