It is more than occasionally that someone asks us about Social Security (“SS”). Often seniors about to begin receiving or already receiving are concerned about their benefits being cut. Younger US Citizens very often express their belief that Social Security will not be there for them. Anytime there is political debate about how to improve Social Security’s financial position, it seems politicians go weak in the knees and develop a stutter. Seniors represent a very large, vocal and active voting base.
Every year, the Trustees of Social Security and Medicare (“The Trustees”) give a report to Congress. The report reviews the current and projected financial positions and sustainability of the programs. A brief, two page report has been posted under Alert Items on our website: https://totalwpm.com/resources . There is PDF file there for download and review for those who wish and the information in this commentary comes from that report. This commentary will focus just on the SS portion.
Good News for Those Receiving SS Now
Annually, the SS Trustees decide if and how much of a raise to give to current recipients of SS. Any raise is based on overall inflation. Inflation has been running very low for many years now and seniors often complain about how little increases are. For 2018, The Trustees have decided, based on inflation, to give current recipients of SS a 2.2% increase.
Bad News for the Program
At the current time, SS is not quite a Ponzi scheme operation. The amount that workers are paying into the system is currently more than costs. However, costs are rising and as Baby Boomers continue to retire and cease contributing to the funding of the SS Trust Fund, SS is projected to bring in less than new costs by 2022. That will cause the SS Trust Fund to begin drawing on reserves. Those reserves are expected to be exhausted by 2034. When that happens, SS will become a true Ponzi scheme (it may be argued that it already is) where the only way to payout to recipients is to take in funds from others who are still working. Were an insurance company to be operating with these projections, the regulators would likely shut it down and there could potentially be criminal charges brought against the executives.
Today, SS is often referred to as an, “Entitlement.” This implies that just because someone exists, something is due them. Specifically regarding SS, if one pays into the system then one is entitled to receive it.
SS, however, was not originally designed as and is today not actually an entitlement. It is, in fact, insurance. The actual formal name for SS is, “Old-Age and Survivors Insurance.” A disability insurance protection was added to SS and now it is officially the, “Old-Age and Survivors and Disability Insurance,” program, or “OASDI.” This is why many see on their paystubs the abbreviation, “OASDI.”
Insurance companies analyze the risks for offered coverages over a large group of people (or properties, etc.). From that analysis, they calculate how much they are likely to pay out in benefits over time and adjust their premiums to provide for the payments and to put some in reserves for future anticipated payments and as a cushion against miscalculations in their estimates. The cushion funds are then invested to earn a return that will aid in making the future payments expected.
A type of insurance is an annuity. Unlike life insurance, where one must die for a benefit to be paid, an annuity is like an upside-down life insurance policy where, in its most basic form, one must live to collect the benefit. This is very similar to SS.
Except, when an insurance company and a customer enter into an annuity contract, the company is obligated to stick to the terms of the contract by contract law. If the insurance company later finds that it underestimated how long the recipient would live, the company cannot change the payout schedule or rate. Congress, on the other hand, does not have to abide by the contract laws of insurance. This is why so many of the proposals to “fix” SS involve violating the contract made with the premium-paying citizens.
Some Proposed Fixes
Increase the payroll “tax” (actually an insurance premium) that funds SS is one proposal. This views SS payments as a tax, not a premium, and the benefits paid are an entitlement, not an insurance benefit. Imagine a customer signed a contract with an insurance company at age 21, agreed to make set premiums of $150 per month until age 65 and then the insurance company would begin paying the customer a set amount per month for life. What would be the reaction of the customer if at age 41 the insurance company sent a notice that said the premium would be increased to $200 per month with no increase in benefit? Likely there would be a lawsuit and the Government would force the insurance company to abide by its contract.
Currently, the amount of wages on which one must pay the SS premiums is capped. Anything a worker makes above that cap does not have SS premiums withheld. Sometimes when people who did not know there was a cap first hear it they become angry, thinking it is just a ploy to help the rich. Actually, when one understands that SS is insurance, the “taxes” are actually premiums and payments are benefits not entitlements, then it begins to make sense. SS benefits paid in retirement are based on a worker’s earnings; the more one earns the more one pays and the more one will receive in benefits in the future. At a certain point, though, any further payment would not increase future payments to be made. That point, for 2017, is $127,000. Would an insurance annuity customer keep a policy that charged an extra premium with no increase in benefit? Of course not and, in the world of insurance law, that would hardly be legal in the first place. When the pundits and politicians speak of this option, “To save SS,” the concept of premium and benefit rarely is considered.
Raising the retirement age is another oft-stated proposal. The argument is that people are living longer and so the full retirement age should be raised. Currently, those born in 1960 or later have a full retirement age for SS purposes of 67. If contract law were applied, this would not be allowed. However, it has been done in the past and may be done again, as this is one of the more frequent proposals.
A proposal that makes politicians quake more than SS recipients is cutting benefits. The current Trustees’ report says benefits would need to be cut 17% across the board for all recipients, present and future, or 20% for just those beginning to receive benefits in 2017 or later. Imagine the outcry from citizens; politicians imagine the voting. Akin to this would be changing the benefit formula used to calculate the benefit payments and/or calculating the cost of living adjustments differently. These are really the same thing and would result in cuts, though might provide politicians a little bit of cover. Again, an insurance company would not be allowed to do this due to contract law.
One bright spot in all of this is to consider how horribly wrong the Government’s calculations have been regarding SS in the first place. The projections change from year to year and it is possible that changes in the underlying economy and an increase in the work force participation rate could unexpectedly change the projections favorably.
Older citizens are tending to work later into what were once considered retirement years. This has two benefits. First, the workers continue paying into the system longer. Secondly, they generally delay taking the SS benefits.
Immigration reform is being discussed. If immigration rules were changed to allow more legal immigration into the country, then the worker base that pays into the system could be increased.
Illegal immigration has some curious effects that are hard to quantify. First, some illegal immigrants work “under the table” and do not pay into the system, but are often counted as part of the population that will receive benefits. Others provide a SS number that is not theirs and actually pay into the system, but are not supposed to receive benefits, but the Trustees likely presume in their calculations that anyone paying into the system will collect benefits and that may not be the case. Additionally, much of this population is made up of younger people. Were a way to be found to bring them into the workforce legally to pay into the system, this could change the numbers substantially for the better. If that does not happen, because so many are younger they are likely to have US citizen babies born to them that will be able to one day enter the work force and it seems likely this effect on the SS system is not fully appreciated.
Retirement Planning and SS
SS has become a bedrock of retirement planning. It was never designed to be a total solution, but a piece of a person’s retirement resources. Too many have come to believe that SS is supposed to provide all their needs in retirement. When one considers the current cost of living and what SS is due, under current law, to pay to them, it should be obvious that one needs other resources.
For those close to retirement or already receiving SS benefits, it is highly unlikely that any substantial change will be made to those benefits. Remember the quaking politicians.
The more impacted clients are those who are younger, in their teens, twenties, thirties and forties. Knowing that it is likely that things will change (full retirement age, removal of the cap, adjustment of calculations, means testing, etc.), it is a difficult consideration. Therefore, when planning for retirement among the younger population, it is often a good idea to plan as if SS would pay no benefit. That is likely too extreme and it will probably be there, but the benefit too far into the future is a major unknown.
Calculating retirement plans for younger people without SS results in needing to put much more away for retirement. Sadly, younger people often put off beginning to save for retirement until later in life. The longer one waits to begin, the more must be saved out of each remaining paycheck.
We encourage our clients who are receiving SS not to be overly concerned about their benefits and any potential changes. We also encourage those more seasoned in life to encourage the young people in their lives to begin saving for general needs and for retirement without delay. Regardless of age or circumstance, TWPM is here to help people plan for their retirement and other financial needs.
Richard Tomes, CFP®
Total Wealth Planning and Management, Inc.
822 A1A North, Ste. 310
Ponte Vedra Beach, FL 32082
Opinions expressed are those of Richard Tomes solely and subject to change. While not guaranteed, the information herein is thought to be accurate as of the time it was written.