About that Social Security Insolvency

Social Security’s future solvency has become one of the most commonly-discussed issues in retirement planning—and for good reason.  Gallup polls show that an estimated 57% of retirees rely on Social Security as a major source of retirement income—a number that has held steady since the early 2000s.  But when Generation X and Y individuals plan for their future retirement, they’ll often ask their advisor to assume that Social Security won’t be there for them 20 or 30 years down the road.

However, if you look closely at the numbers, you see a very different story.  Up until 2011, the Social Security system actually collected more revenues from workers’ FICA payments than it paid out in benefits—and that has been generally true since the 1940’s.  Most of the Social Security benefits that people receive today are simply a transfer; that is, the money is collected from worker paychecks (and, of course, employer matches), spends a few days at the U.S. Treasury and then is paid out to recipients.  The surplus has been used to pay government operating expenses, and for seven decades, the government issued “special issue federal securities” (essentially fancy IOUs that pay interest) to the Social Security trust fund.

In 2011, the program crossed that threshold where benefit payments slightly exceeded the amount collected.  Why?  Because the number of beneficiaries, compared to the number of workers, has steadily increased.  In 1955, there were more than eight workers paying into Social Security for every beneficiary.  Today, that number is closer to three workers for every beneficiary, and by 2031, if current estimates are correct, that ratio will fall to just over two workers supporting every retired beneficiary.

When Social Security Administration actuaries crunch the numbers, they have to take into account the shifting demographics, and then make estimates of fertility and immigration rates, longevity, labor force participation rates, the growth of real wages and growth of the economy every year between now and 2078.  After adding in the value of the government IOUs, they estimate that if nothing is done to fix the system, the trust fund IOUs will run out in the year 2033.  At that time, only the FICA money collected from workers would be available to pay Social Security beneficiaries.  In real terms, that means the beneficiaries would, in 2034, see their payments drop to 77% of what they were promised.

In other words, the money being transferred from current workers to beneficiaries through the FICA payroll program, assuming no course corrections between now and 2033, will be enough to pay retirees 77% of the benefits they were otherwise expecting.

The government actuaries say that if nothing is done to fix the problem over the next 63 years, this percentage will gradually decline to 72% by the year 2078.

So the first takeaway from these analyses is that today’s workers are looking at a worst-case scenario of only receiving about 75% of the benefits that they would otherwise have expected to receive.  This is far different from the zero figure that they’re asking their advisors to use in retirement projections.

How likely is it that there will be no course corrections?  There are two possible ways that this 75% figure could go up.  One lies in the assumptions themselves.  The Social Security Administration actuaries have tended to err on the side of conservatism, presumably because they would rather be pleasantly surprised than discover that they were too optimistic.  But what if the future doesn’t look as gloomy as their assumptions make it out to be?

To take just one of the variables, the actuaries are projecting that labor force participation rates for men will fall from 75.5% of the population in 1997 to 74% by 2075, while the growth in female workers will stop their long climb and peter out around 60%.  If male labor force participation rates don’t fall, and if female rates continue to rise, some of the funding gap will be eliminated.

Similarly, the projections assume that the U.S. economy’s productivity gains (which drive wage increases) will grow 1.3% a year, well below long-term U.S. averages and certainly below the assumptions of economists who believe that biotech and information age revolutions will spur unprecedented growth.  If real wages were to grow at something closer to the post-Great Recession rate of 2% a year, then more than half of the funding gap would be eliminated.  If the current slump in immigration (due to tighter immigration policies) is reversed, and the economy grows faster than the anemic 2% rates the Social Security Administration is projecting (compared to 2.5% recently), then the “bankrupt” system begins to look surprisingly solvent.

A second possibility is that Congress will tweak the numbers and bring Social Security’s long-term finances back in balance, as it has done 21 times since the program originated in 1937.  The financial press often cites the fact that the total future Social Security funding shortfall amounts to $13.6 trillion, but they seldom add that this represents just 3.5% of future taxable payrolls through 2081.  Small tweaks—like extending the age to collect full retirement benefits from 67 to 68, raising the FICA tax rate by 3.5 percentage points or making the current 12.4% rate (employee plus employer match) apply to all taxable income rather than the $118,500 current limit—would restore solvency far enough into the future that today’s workers would be comfortable adding back 100% of their anticipated benefits into their retirement projections.

How likely is it that Congress will take these measures, in light of recent partisan budget battles?  It’s helpful to remember that older Americans tend to vote with more consistency than younger citizens.  The more you’ve paid into the system, the more you expect to at least get back the money you were promised.

The bottom line here is that if you’re skeptical about Social Security’s future solvency, then you should pencil in 75% of the benefits you would otherwise expect—rather than $0.  Meanwhile, as you approach the age when you’re eligible for benefits, watch for signs that immigration restrictions are loosening, the economy is growing faster than the SSA actuaries’ gloomy projections, more people are working during traditional retirement years or yet another round of tweaks from our elected representatives.

If you would like to review your social security payment options or projections, analyze your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

http://economix.blogs.nytimes.com/2014/03/05/another-way-to-do-the-math-for-social-security-reform/?_r=0

http://www.treasury.gov/resource-center/economic-policy/ss-medicare/Documents/ssissuebriefno.%205%20no%20cover.pdf

http://www.treasury.gov/resource-center/economic-policy/ss-medicare/Documents/post.pdf

http://www.wsj.com/articles/how-social-security-benefits-are-calculated-when-you-wait-to-start-taking-them-1421726460

http://www.usatoday.com/story/money/personalfinance/2013/11/25/nine-surprising-social-security-statistics/3698005/

http://www.huffingtonpost.com/2013/02/18/change-social-security_n_2708000.html

http://www.therubins.com/socsec/solvency.htm

http://www.encyclopedia.com/topic/social_security.aspx

http://fdlaction.firedoglake.com/2012/04/30/growing-number-of-americans-expect-to-rely-mostly-on-social-security/

TheMoneyGeek wishes to thank guest writer Bob Veres for this post.

What Is the Difference Between Disability Insurance and Long-Term Care Insurance?

Disability insurance addresses lost wages that stem from an inability to work. Long-term care insurance, in contrast, addresses expenses associated with medical care provided to you in your home, a nursing home, a rehabilitation center, or an assisted living facility.

Disability insurance policies may address either short-term or long-term needs for income. Short-term disability policies provide coverage on a temporary basis, usually up to several months, while you recover from an accident or illness. Long-term disability insurance provides benefits when a disability is of a more permanent nature. Most long-term disability policies will cover you throughout your working years, usually until you reach age 65. Policies vary considerably in terms of the cost of premiums, the percentage of your prior salary paid out as a benefit and the definition of what constitutes a disability.

Long-term care insurance is designed to help cover costs of health care services provided to you in your home, a nursing home, a rehabilitation center, or an assisted living facility. Many long-term care insurance policies provide benefits when you require assistance with activities of daily living such as bathing, dressing, and feeding yourself. Loss of wages typically is not an issue with this type of coverage.

Long-term care insurance can be purchased at any time in your life. However, premiums tend to rise considerably with age and applicants can be turned down due to pre-existing medical conditions. Although individuals of any age may receive benefits from a long-term care insurance policy, these policies typically are intended to help finance the medical costs of the aged.

Why do many financial experts recommend their clients purchase both disability and long-term care insurance?

•    According to the Social Security Administration, a 20-something worker today has a 30% chance of becoming seriously disabled before reaching retirement.1
•    The average daily charge for a semi-private room at a nursing home is $207. The average monthly charge for care in an assisted living facility is $3,450. 2

If you’d like to know more about disability and long-term care insurance, or if you want to discuss other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.

Sources:
1 Social Security Administration.
2 Genworth, 2013 Cost of Care Survey, March 2013.

Towards Better Social Security Income Planning

As you approach your social security retirement age, your thoughts turn to deciding when you should begin receiving social security benefits. With over 2,700 rules in the social security manual, you’d be forgiven (and, for that matter, so would most social security case workers) for being bewildered and confused about all of the options available to claim social security. In this article, I attempt to distill the most frequently asked questions and help reduce confusion about claiming social security benefits (SSB).

The crux of this article is to discuss the advantages of planning the payout of your (or your spouse’s) benefits to maximize your ultimate financial payoff. Coordinating your benefits with your spouse’s benefits introduces complexities that must be understood to maximize your overall benefits. Combined with the ability to file for benefits, then suspend them or filing for benefits using your ex-spouse’s earnings records, planning for social security benefits can be quite complex.

I realize that, as a financial planner, it’s somewhat self-serving to say that each person’s situation is unique and requires a personalized and thorough analysis of the facts and circumstances to determine the optimal timeframe to claim SSB. Nonetheless, no article, however detailed, can take into account all individual situations.

Note that this article doesn’t attempt to discuss the viability of the social security system or whether benefits will be available in the future (I believe that they will be, perhaps on a somewhat reduced basis).

Social Security Basics

In general, if you’ve worked and sufficiently paid into the social security system for at least 40 quarters of work in your lifetime, you probably have some SSB coming to you when you retire. Calculation of the level of your benefit is quite complicated, but mostly affected by your lifetime earnings.

Even if you’ve never worked a day in your life, your spouse’s (or ex-spouse’s) earnings and qualifications may be your “ticket” to qualify for benefits. If you’ve earned little money in your lifetime (as is the case for a stay-at-home spouse), you can often qualify for a much higher benefit if you file based on your spouse’s (or ex-spouse’s) earnings.

There are three dates in which to begin drawing social security: early retirement age (ERA), full retirement age (FRA) and deferred retirement age (DRA), each one being a later date in life than the previous. Your ERA and FRA vary depending on your birthday, and are generally higher for younger retirees (for anyone born after 1959, their FRA is 67).  For general discussion purposes, let’s assume that age 62, 67, and 70 are the ERA, FRA, and DRA respectively.

Deferring the date that you begin receiving benefits obviously means that you (and your spouse) may receive higher benefits per month until your date of death. Currently, less than 50% of filers wait until their FRA to claim benefits, and less than 6% wait until their DRA to claim benefits, despite the much higher DRA benefit (about 75% higher). The DRA benefit is generally about 30% higher than the FRA benefit. Reasons people cite for not deferring benefits include financial need, bad health, fear of social security insolvency, dying early, or plain ignorance about the overall benefits of waiting.

Once you begin receiving benefits, you may have options to suspend them within 12 months of starting them to qualify for a higher later benefit. This mostly involves repaying all of the benefits received. As more fully described below, there may be circumstances where you might want to file for SSB and immediately suspend them at FRA (without receiving payments) to allow your spouse to receive a higher (spousal) benefit or to receive a higher benefit at DRA.

Deferring Benefits

In general, deferring SSB as long as possible makes a lot of sense if you can afford to do so. The significant increase in benefits is primarily due to the additional years of compounding that occurs when you defer benefits.

At its very core, social security is exactly like taking the sums that you contributed into the system over your working years and continuing to invest it. Just like any investment, the primary factors that affect the payout are the length of time for compounding and the rate of return applied. The longer you wait for benefits, the larger the invested sum grows.

Making a decision to begin or defer benefits is an exercise in making a best guess on how long you (and your spouse if you’re married) will live. “Gaming” social security is about maximizing the benefits you collect over your lifetime. Deciding to defer social security until age 70 is a losing proposition if you’re in bad health and don’t have much of a chance to make it to or much past that age. Conversely, if you’re healthy and your family has a past history of living well into their nineties, deferring benefits may or may not lead to a higher overall lifetime payout. Obviously, the “game” ends when you die, since your benefits cease then. So just like investing, the outcome of the decision to defer isn’t known until the investing and disbursement period is over.

Essential Rules/Facts

Given the forgoing background, here are some of the essential rules/facts to know about filing for SSB and some potential tax planning points:

1.    At full retirement age (FRA), one may receive the higher of their own retirement benefit or a spousal benefit equal to 50% of their spouse’s retirement benefit.  Many do not realize that in order to claim that spousal benefit, the spouse on whose record the 50% payment is based must be receiving or have filed for (and perhaps suspended) retirement benefits.

2.    If a worker starts benefits prior to his/her FRA, and his/her spouse is receiving retirement benefits, the worker does not get to choose between their retirement benefit and a spousal benefit. They are automatically deemed to have begun their retirement benefit, and if their spouse is receiving retirement benefits, a supplement is added to reach the spousal benefit amount.  All this is reduced for starting early. The total will be less than half the normal retirement benefit.If you start your retirement early and your spouse has not claimed or suspended his/her retirement benefit, you cannot get a spousal supplement until they do file.

3.    A person needs to have been married to an ex-spouse for at least ten years immediately before a divorce is final, in order to be eligible to receive a spousal benefit based on a former spouse’s record. The ex-spouse need not approve this and may never know this is the benefit being claimed.If you marry again, you are no longer eligible for a spousal benefit on your ex’s record and a new 10-year clock starts on the marriage to your new spouse. If you are over 60 when you get married again, you will still be able to claim survivor benefits on your ex.

4.    If you take your retirement early, it not only reduces your retirement benefits, benefits for your survivor (if any) are also based on that permanently reduced amount.

5.    If you have claimed your retirement benefit early, when you reach your FRA, if your spouse then files for his/her retirement and you want to switch to a spousal benefit, you will not get 50 percent. The formula is (A-B) + C where A= ½ the worker’s Primary Insurance Amount (PIA, their benefit at their FRA), B= 100 percent of the spouse’s PIA, and C= the spouse’s EARLY retirement benefit. Since starting early means C is less than B, the total is less than 50%.  One only gets half their spouse’s benefit if the spousal benefit is claimed at FRA.

6.    Spousal benefits do not receive delayed credits. In other words, if taking the spousal benefit is good for a couple, delaying the claim for spousal benefits past the recipient’s FRA has no additional benefit.  The same applies for widow/widower benefits. They can be started early but there is no benefit to delaying past FRA as no delayed credits apply. Before a worker dies, delaying does increase the potential survivor’s benefit.

7.    Taxpayers whose income is low can find that some forms of tax planning can result in higher than expected taxation. Many retirees will make distributions from IRAs or qualified retirement plans prior to age 70½ to have a low tax rate applied. Roth conversions are often done for the same reason. A relatively small amount of taxable income can cause up to 85% of Social Security payments to become taxable.

8.    Because the income thresholds that determine how much of one’s Social Security is taxable are not indexed for inflation, over time, more and more of the benefits can become taxable.

9.    New this year, an increase in taxable income as just described can also cause a reduction or elimination of subsidies available to lower income households under the new health insurance law. Social Security payments, even the tax-exempt portions, are included in this evaluation. Supplemental Security Income (SSI) is excluded.

10.    With today’s mobile workforce, it is not unusual to find some taxpayers that worked at a job and earned a pension benefit but were not subject to withholding for Social Security taxes and another job that was subject to Social Security taxes. Many such folks are unpleasantly surprised that their Social Security benefits may be reduced due to the Windfall Elimination Provision.

11.    If you “file and suspend” for SSB, Medicare premiums cannot be paid automatically from Social Security income and must be paid directly to the Center for Medicare & Medicaid Services (CMS). Affected taxpayers should be sure to get billed properly by CMS. If it is not paid timely, you can lose your Medicare Part B coverage.

12.    When collecting retirement benefits, increases in Medicare Part B premiums are capped to the same rate of increase of the retirement benefits under a “hold harmless” provision.  This is tied to actual receipts so while delaying past your FRA earns delayed credits, there is no cap on the Medicare increases. Worse yet, the uncapped increase is locked into every future premium. This hold harmless quirk is not relevant to high income taxpayers. Hold harmless does not apply to high income taxpayers paying income-related Medicare B premiums.

13.    Because it used to be allowable to pay back all of your retirement benefits and start over, many people think that they can change their minds about starting SSB early. Withdrawing your claim this way basically erased the claim as though it never happened and future benefits would therefore be higher. Today, if you regret your choice, you can only withdraw your claim and pay back benefits within 12 months of your early start. After 12 months, you are stuck with your choice until your FRA, at which point you can suspend and earn delayed credits up to age 70. The credits are applied to your reduced benefit.

Some Strategies and Conclusion

Here are some final considerations to make when deciding to file a claim for SSB (by necessity, these are generalities that must take into account each individual’s/couple’s facts and circumstances):

•    Assess your own life expectancy, and, if married, your joint life expectancy.
•    If married, and either spouse is healthy, delay the higher earner’s benefits as long as possible.
•    If married and one spouse is unhealthy, get the lower payout as soon as possible.
•    Supplement benefits with spousal amounts, if within FRA.

As mentioned above, the decision of when to file for social security benefits can become very complex and requires assessment of many factors. Since the determination can involve differences of thousands of dollars per person, per year, it’s worthwhile to carefully assess and model all of the facts and circumstances before starting benefits.  Even though a total SSB re-do is no longer available, there are some options still available to modify benefit payouts.

It may be tempting or convenient to utilize a simplified web-based social security calculator to help you make an estimate, but be wary of any program that doesn’t model multiple scenarios or doesn’t require entry of many variables that may ultimately affect your optimum benefit. In the end, there’s no perfect answer, but perhaps a “best fit” for your situation is good enough.

If you have any questions about social security planning or any other financial planning matter, please don’t hesitate to contact me or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.

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