Now’s the time to talk about the future of Social Security

One of the most memorable moments of the recent State of the Union address involved President Biden’s sparring with House Republicans over pledges to protect Social Security and Medicare and shield those programs from spending cuts during the looming debate over the debt ceiling.

While the dramatic exchange sparked applause, boos, and likely political slogans for the 2024 presidential campaign, it involved neither details nor timelines of how to protect the programs that are so critical to today’s retirees or how to reform them in ways that are fair to today’s workers who foot the bill.

But at least it’s a start.

Workers who have contributed payroll taxes for decades expect and deserve to receive their promised benefits. But many younger workers are skeptical that they’ll ever reap the rewards of their contributions, particularly in the new world of work that is more likely to involve several different careers and flexible work arrangements than a lifetime with one company and a gold watch.

In an era of disappearing pensions, Social Security is a critical piece of retirement security for most Americans. Only about half of retirees received pension income in 2022, compared to the nearly two-thirds who were getting a pension a decade earlier, according to recent Limra research. The trend accelerates with younger workers. Less than a quarter of workers under 50 will have access to a pension when they retire.

FALLBACK PLAN?

Today more than 65 million Americans receive Social Security, and more than half of them rely on it for 50% or more of their retirement income.

The latest Social Security and Medicare Trustees report projects that if Congress does nothing, the Social Security trust fund will be exhausted around 2035. At that point, there would be enough revenue from ongoing payroll tax collection to fund about 80% of promised benefits — meaning a 20% across-the-board cut in benefits for current and future retirees.

Ironically, the projected trust fund exhaustion date would coincide with the 100th anniversary of the law that created Social Security in 1935. Social Security has never missed a payment since the first monthly check was sent to Ida May Fuller in 1940. But now some financial advisors and their clients wonder whether they need a fallback plan if the once unthinkable scenario of a cut in Social Security benefits actually occurs.

If history is any guide, current and near retirees aren’t likely to suffer benefit cuts. Congress tends to phase in major policy changes over years or decades, as in the case of the last major Social Security reform in 1983. But retirees could be affected in other ways, such as having more of their Social Security benefits subject to income taxes or seeing changes in the way cost-of-living adjustments are calculated.

With clients who are 55 and younger, advisors may want to stress-test their retirement income plan by calculating what a 20% cut in Social Security benefits might do to their overall retirement income plan. And higher-income workers might have to pay more payroll taxes in the future without receiving bigger retirement benefits.

At this point, it’s impossible to know what Social Security benefits might look like for today’s youngest workers. But that’s a question that the InvestmentNews staff plans to ask policy and financial experts in the coming months about their vision for the future of Social Security in the 21st century. After all, Social Security was designed in the mid-20th century, when families were usually headed by a single breadwinner and few women were in the workforce.

We also want to hear from advisors about the questions clients are asking about Social Security and how advisors are responding to those questions.

FEARFUL FILING LOCKS LOSSES

Some clients may want to grab their benefits as soon as possible at age 62 as a hedge against future benefit cuts. While there may be good reasons to file for reduced Social Security benefits early, claiming Social Security prematurely out of fear is a bit like selling stocks in a down market: All you’ve guaranteed is that you’ve locked in a loss. And if future benefit cuts did materialize, the benefits of those who claimed as soon as possible would be reduced even further.

Over the past few years, most House Democrats have backed bills that would expand existing Social Security benefits for vulnerable populations such as the poor, widowed and caregivers, and pay for those expanded benefits by increasing payroll taxes on higher-income workers. But there’s been no buy-in from House Republicans, who generally support increasing the full retirement age and oppose tax increases. As a result, existing legislative proposals are more political manifestos and less blueprints for reform.

The political parties are far apart. The solution will require leadership and bipartisan support. Both are in short supply right now. But it’s an excellent time to begin discussions and explore new ideas.

(Questions about new Social Security rules? Find the answers in Mary Beth Franklin’s 2023 ebook at MaximizingSocialSecurityBenefits.com.)