What millennials should expect from Social Security

I often get questions from financial advisers and younger workers about how much millennials can reasonably expect to receive from Social Security given the latest trustees’ report that projects trust fund reserves, which currently help fund Social Security benefits, will run dry in 2035. If that happens, Social Security would only be able to pay 80% of promised benefits.

A new paper from HealthView Services quantifies the impact of those projected benefit cuts on younger workers’ retirement plans and how much they would need to save to make up the shortfall.

The primary cause of Social Security’s funding challenges is demographics. The number of workers contributing to Social Security is going down and the number of retirees receiving benefits is going up. In 2005, the number of workers per Social Security beneficiary was 3.3. In 2020, that ratio declined to 2.7 and by 2035, it’s expected to decline to 2.3.

The 2022 trustees report notes that changes will be needed to increase funding or reduce benefits to address Social Security’s solvency issues, much the way Congress adjusted program rules and taxes in 1983 — the last time the nation’s retirement system faced a financial shortfall.

To avoid a 20% across-the-board cut in benefits for all current and future retirees once the trust funds are exhausted, Congress could approve a variety of changes, such as increasing the payroll tax rate or the amount of wages subject to payroll taxes, gradually raising the full retirement age from 67 to 69, and altering how benefits are calculated and adjusted for inflation.

Currently, workers and employees each pay 6.2% of the first $147,000 in wages to fund Social Security benefits. Self-employed individuals pay a combined rate of 12.4% on up to $147,000 of net self-employment income.

In the past, Congress has approved changes that mainly affect workers who are decades away from retirement, which in this case would be millennials, born between 1981 and 1996.

Millennials have always been skeptical that Social Security will play much of a role in their retirement. In fact, nearly half of millennials strongly agree or somewhat agree that they “won’t get a dime” in benefits, according to a 2021 survey by Nationwide Financial.

“These benefits will clearly be less valuable to them than past generations,” Ron Mastrogiovanni, CEO of HealthView Services, said in a statement accompanying the study. “But what may be a surprise is that even with a 20% reduction, Social Security will continue to be a significant source of retirement income for members of this generation.”

If benefits are reduced by 20%, an average 35-year-old millennial earning $50,000 in 2022 will receive $13,500 less in annual Social Security income in the first year of retirement, the report said. If they make between $100,000 and $150,000 in 2022, Social Security benefits would be reduced by $21,000 to $25,000 in the first year of retirement.

The age at which benefits are claimed will have a significant impact on millennials’ Social Security income.

Assuming a retirement income replacement ratio of 80% at the current full retirement age of 67, Social Security benefits would cover 30% to 48% of income needs in the first year of retirement. Early filing would reduce this to as low as 20% for a higher earner. Conversely, delaying claiming up until age 70 would increase benefits. For a millennial earning $50,000 today and filing at age 70, benefits would cover as much as 60% of their income needs in the first year of retirement.

The savings required to make up the difference between current Social Security benefits and the smaller checks that millennials should expect are relatively modest, given millennials’ long retirement horizon. With a 50% employer match, a millennial currently earning $100,000 per year would need to invest an additional $2,543 a year from 2022 until retirement, the report said. That amounts to an extra $33 per week.

The paper also looked at the impact of extending full retirement age from 67 to 69 and continuing to pay 100% of promised benefits. Increasing full retirement age decreases lifetime benefits.

If the full retirement age was raised to 69, a 35-year-old making $100,000 this year would lose $375,000 in lifetime benefits if they claimed at 67 or $210,000 if they claimed at 69. Raising the full retirement age by two years is the equivalent of reducing lifetime benefits by 13.3% if they claimed at 67 or 7.5% if they claimed at 69, compared to current law.

Underscoring the benefit of delaying claiming to maximize lifetime Social Security income, the HealthView Services report notes that today’s 35-year-old earning $50,000 annually would increase their first year’s Social Security benefits by $40,000 by claiming at 70 rather than 62. A millennial earning $150,000 today would increase their first year annual benefits by $75,000 by delaying until age 70 compared to claiming at the earliest age of 62.

[More: 401(k) plans are failing middle-class Americans]

(Questions about new Social Security rules? Find the answers in Mary Beth Franklin’s new 2022 ebook at Maximizing Social Security Benefits)