About that Social Security trust fund running out...
Let’s touch on a few points regarding Social Security retirement benefits that are coming into sharper focus in the current economic crisis.
In general, one should avoid beginning benefits prior to Full Retirement Age (FRA), which is age 66 for persons turning 66 this year and which will gradually increase in future years. While benefits can begin as early as age 62, the cost of doing so is a permanent 25% lifetime reduction of benefits. Unless one is under tremendous financial or medical distress, drawing benefits prior to FRA can be a costly and irreversible mistake. Second, one can defer benefits to age 70, and the benefit will increase by 8% per year. The point at which the cumulative higher monthly benefits starting at age 70 are equal to the cumulative lower monthly benefits beginning at age 66 may be referred to as the “break-even point.” Putting aside inflation adjustments and time value of money considerations, the break-even point is around 85 years of age. If one has parents who lived well into their 90s, one might be tempted to consider deferring to age 70, especially if one has sufficient current income and no debt. On the other hand…
People taking income at FRA will have more income during the years when they are more active and more likely to travel and otherwise expend discretionary income, as opposed to later years when health care costs tend to increase and people lead less active lives.
The most optimistic projections of the Social Security trust fund indicate that it will be out of money in 14 years. The current economic difficulties could accelerate its bankruptcy. A proposed cut in payroll taxes would inflame the problem further, if enacted. If no action is taken, all benefits will be reduced by 21% when the trust fund runs out, under current law.
“Congress will never let that happen.” Maybe. Maybe the younger generation will wish to further subsidize the generation that ran up $20 trillion in debt and left them with the tab, and to pour several more trillions into a program that they do not believe will ever benefit those younger generations. Maybe. Based on history, we can prophesy that Congress will not come up with any resolution until the last possible moment, and that will be at a time when the rising electorate is younger and increasingly skeptical of receiving any benefits. And of course we don’t even want to think about the fact that the Medicare deficit is an even bigger problem.
There is only one way the situation can play out. It is already in its incipient stages.
High earners pay “tax” on 85% of their SS income, and others on a sliding scale. In essence, it is not a tax, in the sense that it does not flow to the U.S. Treasury; it is more accurately described as a “claw-back” that is remitted to the Social Security trust fund. These hundreds of billions in claw-backs are vital to keeping the entire program afloat.
While it may be a principle of fairness that everyone would get back at least what they paid into the program, plus perhaps the rate of interest paid on the Social Security trust fund, which is invested in Treasury bonds, the “excess” benefits that are paid to wealthy people will surely be curtailed. This will be done through “taxation” so that politicians can say that benefits have not been cut, although the rate on those benefits will increase far above the general tax rate so as to become a more obvious claw-back. Reducing net benefits to the wealthy is the least painful and most politically palatable way of reducing costs. The question is: what is wealthy? Warren Buffett and Donald Trump certainly can go without, but the numbers will surely require significant curtailment of payments at a far lower income. Might it be $500,00? $250,000? $100,000? Lower? The final numbers are likely to be more painful than we would like to imagine if the program is ever to be structured in a sustainable way. There is no realistic solution other than means-testing.
The bottom line: waiting for age 70 may yield more in pretax “paper” income, but far less in real after-tax income.
In short, a bird in the hand…
Michael Muldowney is the author of I Was a Teenage Liberal and is a financial advisor in Glen Allen, Virginia.