Social Security’s Past, Present and Future

When designed back in 1935, Social Security was largely a pay-as-you go system focused on providing financial security to the elderly. Over the years, programs were added to include benefits for the disabled, widows and children. Today, over 59 million people receive almost $870 billion in benefits from one of several Social Security Administration programs. For 53% of married couples and 74% of unmarried persons, Social Security benefits represent 50% or more of their income.

Unfortunately, Social Security’s funding status has not kept pace with its growing scope. As the chart to the right shows, the growing number of people over 65 relative to the number of workers (i.e., the dependency ratio) is wreaking havoc on the system’s finances. Without changes, the system is currently forecasted to exhaust its reserves by 2035.

This dismal outlook is not new; economists have been predicting Social Security’s demise for years. But what is new is the urgency around finding a solution and the range of options now being considered. The first shot over the bow occurred without much fanfare last week when law makers adopted Social Security rule changes as part of the recent budget deal. Specifically, two types of popular claiming strategies aimed a maximizing married couples’ retirement benefits were eliminated.

The first, “file and suspend”, allowed a married person of at least full retirement age to file for a benefit based on his or her own earnings record and then immediately suspend it. The spouse, typically the lower earner, could then file for spousal benefits while the higher earner’s benefit (that was suspended) grew at approximately 8% per year up until age 70. This option, which allowed the higher earner’s benefit to grow while the lower earner collected spousal benefits, will no longer be available after May 1st of next year. Fortunately, those already using the strategy will be grandfathered in until age 70.

The practice of using a restricted application to maximize benefits also will no longer be allowed. Up until now, individuals eligible for either a benefit based on their own record or a benefit based on their spouse’s record could elect only a spousal benefit at their own full retirement age. After May 1st, only individuals born on January 1, 1954 or earlier can use this option. Anyone younger will loose the option to elect and automatically get the larger of the two benefits. The rules governing claiming strategies can be complicated so we encourage anyone nearing full retirement age to carefully review their options.

Up until now, politicians on both sides of the aisle have avoided addressing Social Security’s funding issues due to fears of alienating supporters of the widely popular program. But the relatively easy passage of the recent bill curbing benefits suggests change may be sooner than we think. Historically, Republican solutions focused on market based initiatives such as introducing Private Savings Accounts. GOP policy prescriptions today, however, seem to have shifted left. Republican presidential contender Chris Christie, for example, supports reducing benefits for those earning over $80,000/year and eliminating them entirely for those with incomes over $200,000.

Democratic proposals are targeting benefits for the wealthy (i.e., means testing) and raising taxes to fund benefits. Bernie Sanders, for example, supports raising the cap on the income subject to payroll taxes and expanding benefits.

Fortunately, Social Security reform no longer appears “off limits”. Efforts to expand benefits and raise taxes will likely remain controversial, but both parties seem to acknowledge that some form of means testing is needed. Raising the retirement age (given expanded life spans) is receiving bipartisan support as well. Whatever the ultimate compromise, the system is likely to be more progressive, and focused on meeting the needs of the poorest seniors than it is today.

Retirement Planning By The Numbers

For many people, the retirement world is a foreign place full of unfamiliar concepts and terminology. To help navigate the often complex range of retirement related decisions, financial planners have come up with a number of statistics. A review of some of these guidelines along with a few other related metrics follows.

80%   How Much Pre-Retirement Income You Need in Retirement.

The thinking is, even though you have more opportunity to spend in retirement, many of the expenses you incurred before you stopped working are gone. Recent research by Morningstar indicates that while retirees do indeed tend to spend less, how much less varies by income level. Those who earn more, ironically, spend a smaller percent of their pre-retirement income as many of life’s big costs (college education, retirement funding etc..) disappear. Not surprisingly, we see a great deal of variability around retirement spending habits in our own practice. For most, spending follows a U curve with higher expenses early on in retirement for things like travel, a drop later as people age and then a pick-up again at the end of life for healthcare spending (see below.)

4% The withdrawal rate that can be sustained over an average retirement.

The 4% withdrawal rate is probably one of the most widely used and least understood “shortcuts” used in retirement planning. The concept is that investors who limit their initial withdrawals to 4% of their portfolio’s market value (and then adjust that for inflation) have a 90% chance of maintaining their portfolio over a 30 year retirement. While this metric provides a decent “ballpark” estimate, investors should be careful not to rely on it too heavily for several reasons. First, the supporting research assumes that portfolios are invested according to a 60% stock and 40% bond mandate. Many investors will not adhere to this strategy throughout retirement. Second, recent studies have pointed out that the order of returns not just the average level has a big impact on portfolio longevity.  Individuals who begin retirement during a market downturn, for example, experience much worse outcomes than those who retire during a strong market.  A better approach? If you have the bad luck of experiencing poor market returns early on in retirement, consider reining in your spending until market valuations improve and then re-evaluate your withdrawals every few years.

76%  The increase in monthly benefit you can expect by delaying claiming Social Security from 62-70.

The benefits of delaying taking Social Security are well worth repeating. When Social Security began back in 1935, the average American worked until age 65 and had an average life expectancy of 66.5 years.  Today, the average retirement lasts well over 25 years. If you cannot afford to delay claiming or have reason to believe you may not live past 80 than this approach may not make sense but for many it is one of the best ways to ensure that you don’t outlive your funds.

60% The percent of total lifetime healthcare expenditures incurred during the last 6 months of life. 

Healthcare costs can be a big unknown for retirees.  Practicing healthy habits like getting plenty of exercise and eating well can go a long way to reducing the risk of heavy healthcare spending.  But consider that the average person spends $39,000 on healthcare out of pocket in the last five years of life and the top 10% can spend more than $89,000.  What to do?  Take a careful assessment of your family health history to see if long term care insurance makes sense (see last month’s newsletter). Remember, while Medicare and most private health insurance covers costs such as doctors visits and hospital stays, they do not cover most custodial related long-term care costs.

85 The average life expectancy in America today.

Just imagine how much easier retirement planning would be if we knew exactly how long we will live. While this information is unavailable to us mortals, you can take a stab at estimating your life expectancy at