As we covered in our recent post, When Should You Take Your Social Security?, deciding when to file for benefits can be tricky, and warrants careful analysis.
Most of us have been paying into Social Security our entire working lives, and we’re counting on receiving some of that money back in retirement. But with headlines warning that the Social Security trust fund is set to run dry around 2034, many wonder whether they should file early, delay, or forget about receiving payments altogether.
Haven’t we been here before?
The Social Security program has faced similar challenges in the past. In the 1980s, the Social Security trust fund was facing financial difficulties due to several factors, including demographic changes, increasing life expectancies, and a decrease in the number of workers supporting each beneficiary. This led to projections that the trust fund could be insolvent as early as 1983.
A bipartisan commission was formed in 1981 to develop recommendations for improving the program's financial stability. The National Commission on Social Security Reform was chaired by Alan Greenspan and included members from both major political parties. Key provisions adopted and implemented in the Social Security amendments of 1983 included:
- Increase of the payroll tax rate from 6.7% to 7.65%, phased in between 1984 and 1990.
- Increase in the full retirement age from 65 to 67 over a period of many years.
- Introduction of taxation of Social Security benefits.
- Introduction of the Windfall Elimination Provision (WEP) and Government Pension Offset.
What about this time?
While we don’t expect Social Security to go bust, we expect it will change in the years ahead. As its trustees have reported:
“Social Security is not sustainable over the long term at current benefit and tax rates … [and] trust fund reserves will be depleted by 2034.”
Let’s unpack this statement. First, “depleted” does not mean the Social Security Administration is going to turn out the lights and go home. It means it could run out of trust fund reserves by then, which are used to top off the total amount spent on Social Security benefits. There are still payroll taxes and other sources to cover more than 77% of the program’s payouts. So if the government does nothing but wait for the reserves to run out, it would be forced to make hard choices about an approximate 23% shortfall starting around 2034.
As members of Congress wrangle over the “best” (or least objectionable) solutions, they have been submitting proposals behind the scenes, and the Social Security Administration has been weighing in on the estimated effect for each.
The range of possibilities essentially fall into two broad categories: Pay more in, or take less out. Most likely, we’ll see a bit of both. To replenish the reserves, Congress could:
Pay more in:
- Raise the cap on wages subject to Social Security tax: As of 2023, earnings beyond $160,200 per year are not subject to Social Security tax. They could increase this cap, eliminate it entirely, or reinstate it for income beyond certain high-water marks.
- Increase the Social Security tax rate for some or all workers: Employers and employees each pay in 6.2% of wages, for a total of 12.4% up to the wage cap. (This does not include an additional Medicare tax, which is not subject to the wage cap.)
- Increase the tax on Social Security payouts, and direct those funds back into the program: In 2023, if your “combined income” exceeds $44,000 on a joint return ($34,000 on an individual return), up to 85% of your Social Security benefit is taxable, as described here.
- Identify new funding sources: One recent bipartisan proposal would establish a dedicated “sovereign-wealth fund,” seeded with government loans. Presumably, it would be structured like an endowment fund, with an investment time horizon of forever.
Take less out:
- Extend the full retirement age: There are proposals to extend the full retirement age for everyone, or at least for younger workers. This would effectively reduce lifetime payouts received, no matter when you start drawing benefits.
- Tinker with COLAs: There are also bipartisan conversations about replacing the benchmark used to calculate the Cost-of-Living Adjustment (COLA), which might lower these annual adjustments in some years.
- Reduce benefits: Payouts could be cut across the board, or only for some higher-income retirees.
These are just a few of the possibilities. Some would affect everyone. Others are aimed at higher earners and/or more affluent American persons.
Should any of this impact your claiming strategy?
So, given the uncertainties of the day, should you start drawing benefits sooner than you otherwise would? Many investors feel safer taking their Social Security as soon as possible, to avoid losing what seems like a bird in the hand.
However, it’s helpful to realize that you’re not reducing your financial risks by taking Social Security early. You’re only changing which risks you’re taking. In exchange for an earlier and more assured payout, you’re also accepting a permanent, cumulative cut to your ongoing benefits.
If this still seems like a fair trade-off, consider that Social Security is one of the few sources of retirement income ideally structured to offset three of retirement’s greatest risks:
- Longevity risk: In an annuity-like fashion, Social Security is structured to continue paying out, no matter how long you and your spouse live.
- Inflation risk: The payouts are adjusted annually to keep pace with inflation.
- Market risk: Even in bear markets, Social Security keeps paying, with no drop in benefits.
This is not to say everyone should wait until their Full Retirement Age or later to start taking Social Security. When is the best time for you and your spouse to start drawing benefits? Rather than hinging the decision on uncontrollable unknowns, we recommend using your personal circumstances as your greatest guide. Consider the retirement risks that most directly apply to you and yours, and chart your course accordingly.
This content is developed from sources believed to be providing accurate information as of the date of publication, and is intended for informational purposes only. No content should be construed as legal or tax advice. Please consult your financial professionals for specific information regarding your individual situation. Past performance does not guarantee future results. All investing involves risk, including risk of loss.