What Does A Reduction in Social Security Look Like?

The Social Security Trust fund has been a topic of concern for several years now and is one of the most primary concerns for individuals preparing for retirement. According to the National Institute of Retirement Security, an estimated 40% of Americans rely solely on Social Security for retirement income. 40% is a staggeringly high number and, understandably, a significant cause of concern for many Americans living in retirement right now.

For those of you who may not know, the Social Security Administration publishes an annual report on the state of the American retirement trust fund. It also comes with projections of when it is expected to become depleted. Now, we knew before COVID that the numbers were terrible and that if Congress does not work on passing a resolution, we would inevitably run out of money. We also knew that our country experiencing a labor shortage coupled with high unemployment rates would further impact the numbers coming out of 2020. Still, it was anyone's guess as to how bad that was. Well, the numbers are out, and I took the opportunity to review, and today I'm sharing with you precisely what the projections are. All I can say right now is that they are not pretty!

As I said, we have a fully packed episode today and being that Social Security is of such importance, I want to make sure we take the time to understand the system thoroughly. In my years of experience, many individuals only know the essential components, which is they become eligible at age 62. Still, people rarely see how the system works. So today, we're going to dive into the Social Security system, go over the numbers. Why they are as bad as they are now, we will go over the newly released projected numbers from the Social Security Administration. Lastly, talk about the years and expected decrease in income that retired Americans can potentially face.

Our country didn't always have a government retirement plan system in place. Pre-1930 and the Great Depression era, Americans worked and lived their lives with the only financial backing coming from what they had scrimped and saved. When the Great Depression hit our country, millions of Americans were left not only jobless but for many, also without any savings. It wasn't until 1935 that President Roosevelt signed into law the Social Security Act. This law was designed to pay retired workers an income in their retirement years starting at age 65.

Now keep in mind, back in 1935, longevity and life expectancy were not as high as today. Also, keep in mind that infant mortality was also pretty high. Statistically, only 54% of men could be expected to live to age 65 if they survived past age 21. For those aged 65 to collect retirement benefits, the life expectancy and average time were only 13 years for men and longer for women.

When Social Security was created, there were already 7.8 million Americans aged 65 and older who were immediately eligible for retirement benefits. Again, life expectancy statistics suggested that most would not live through their eighties. However, the statistics and the government could not foresee a sharp increase in life expectancy due to modern medicine. They also did not anticipate the sheer size of the Baby Boomer generation, and the relative number of workers to beneficiaries ratio would eventually start causing the fissures and cracks within our retirement system. In 2020, the Social Security Administration paid benefits to as many as 65 million people a month.

The Social Security Trust Fund is not just about retirement benefits. Social Security benefits are provided to support spouses who have spent their lives working hard to raise their children. Heck, even ex-spouses can still receive benefits on their former spouses’ Social Security benefit as long as they do not remarry. Additionally, benefits are provided to surviving widows and children in the event the primary head of household unexpectedly passes. Over the years, the government expanded benefits to offer aid for those on disability. Since benefits are government-guaranteed until the end of life, it should come as no surprise that we are dipping further into the trust fund than we initially expected.

The Social Security piggy bank is not sustainable for long-term withdrawals at our current rate.

The trust fund running out of money is no secret. We've known about this for years. In fact, in 2013, the annual report suggested that our outflows were catching up to the yearly inflows. In short, money going in was not much higher than money coming out. Fast forward a couple of years, and money going in was matching money coming out, and now money coming out is flowing much faster than the cash going in. The money is coming out so quickly that the most recent report suggests that the Social Security trust fund will run out of money by 2034.

That's right, you heard me correctly. Thirteen years from now, in 2034, the Social Security Trust Fund will be completely exhausted of reserves. That's not to say Social Security will stop in 2034 but that drastic changes will have to occur. If the current anticipated cost of living adjustment for Social Security is correct, we may be seeing an acceleration of that number. Right now, all signs point to the highest COLA adjustment for next year with a rate increase of 6%! Now that number will become finalized and released in October so let's not digress and speculate; we'll just come back to that in a couple of weeks. For now, let's talk about the anticipated Social Security drop and break down the total retirement benefits provided to the modern retiree.

The current retiree is provided health and income benefits. Income is Social Security, and health is provided via Medicare. Based on the most recent report, Medicare Part A is projected to run out of money in 2026 and become insolvent. At that point, they are projected only to cover 91% of Part A claims. Part A is your hospital visits, hospice care, and skilled nursing care for those who may be unfamiliar.

Healthcare is generally one of the largest expense for current retirees.

Medicare Part B, which is your primary care visit, is not of significant concern because current tax laws stipulate that Part B will always be covered by taxes no matter what. So what problem does Medicare Part A becoming insolvent mean? An insolvent system could lead to a more significant number of health care professionals not accepting Medicare.

A healthcare program that cannot fully cover the cost could pass the remaining expense to the individual consumer. Considering how 40% of Americans live on a fixed income, this could be detrimental for many individuals.

The projections for Social Security are that it would be able to maintain 75% of benefits after running out in 2034. That's right, you heard correctly, 75% of benefits. Now imagine receiving $2,000 a month in Social Security and waking up January 5th of 2035 and seeing a deposit of only $1,500. What do you cut that month? I mean, what do you knock out if you're one of the 40% of Americans living from one Social Security paycheck to another?

What happens if you still have a housing payment? Do you beg your mortgage holder or landlord to drop the cost? Do you roll back your electricity usage and pray that you do not freeze to death or overheat because you cannot afford to spend that much money on heating and cooling costs? Or do you eat one less meal a day to make up for the decreased income? Or do you do what millions of retired Americans are already doing, and you set out to work again? But that begs the question, what will you be able to do if you're in your 70s or 80s?

40% of retirees’ only income is from Social Security. What will happen when their benefits get reduced?

Social Security was only intended to become a stop-gap. A system to supplement a retiree's retirement savings, but for many, it has become the only piece of retirement income available. Unfortunately, financial literacy was never a subject of importance in our country. It isn't until now, where the impending failure of the system is imminent, that individuals are becoming concerned. More and more people are beginning to wonder how they will retire if Social Security isn't going to be there in its current fashion. From personal conversations with 401k plan participants, I hear from more and more individuals just starting to kick start their contributions because of the Social Security concern.

So how does a failing system get fixed? Well, improving Social Security is about balancing the numbers. Money coming in needs to match up and exceed money flowing out, which currently isn't the case. So if our annual Social Security expenditures are too high and we need to fill that gap, the only way we can do that is by raising taxes. Currently, all working individuals, as well as their employer, pays Social Security tax. You are taxed 6.2% of your earned income to cover Social Security. Your employer also pays 6.2% taxes to cover their portion of Social Security. Increasing that percentage to something higher would help offset the expenditures. Sounds easy, right? The solution isn't difficult to understand or grasp but passing a tax hike resolution through Congress is not easy. Far from it, actually. Because Social Security is only an effect for retirees, it is challenging to have a majority of the voter base support elected officials coming in to raise taxes. I mean, let's face it, having a tag line for a politician that says, "Vote for me, and I will push to raise Social Security taxes," is not exactly a compelling reason.

Getting a tax hike bill passed through Congress is nearly impossible with how fractured our government system is currently.

Having bipartisan support for a tax hike is not easy to get off the ground, so you can imagine why Social Security reform has not been a subject of discussion these past decades. There's also a vast majority of Americans who may not even become affected by a drop in Social Security. I mean, check this out:

In an August 2021 article by Bloomberg News titled "There Are More 401(k) and IRA Millionaires Than Ever Before," they cited from Fidelity Investments that the number of 401(k)'s with balances of at least $1 million grew 84% year over year to 412,000 while the number of seven-figure IRA accounts grew 64%.

Now that's just one financial institution, but the data isn't very far off the others. Investment returns have been positive and steady in the past couple of years. Americans are now saving in record numbers compared to a decade before, so it's easy to see why those preparing and consciously planning for retirement will be OK.

So as you listening to this, I want to ask what are you thinking and how are you feeling? These fully published numbers indicate that Social Security will run out of money by 2034 and that unless Congress passes a tax hike, you can expect to see benefits decrease by close to 25%.

I have some additional questions that I think would be helpful for you to consider when navigating the Social Security problem, and these I'll break down into two categories of individuals: those already retired and those that are still working.

For those already retired:

If Social Security drops by 25%, are you able to sustain your current lifestyle?

To answer this, you want to add up all of your current retirement income and subtract out your expenses. So add up your monthly Social Security deposit, your pension deposits, if any, your current portfolio withdrawals and from that figure, deduct your monthly expenses. If your net number is positive and you're putting away money towards a savings account, then great, check to see if that excess is more significant than or equivalent to 25% of your current Social Security payment. Suppose that value is again the same or greater, and you're in a position where you can weather a drop in Social Security.

If your income and expenses are equal or the income is just high enough to cover the costs but not high enough to see a 25% decrease in Social Security, then I want you to run this next exercise.

Most individuals only have a certain number of places to draw for retirement, and most of them are fixed. Social Security is that. Pensions and rental income are also predominantly fixed, so we're going to leave all these selected items aside and look at your variable sources. Your IRAs and investment accounts where you can increase or lower your withdrawal rate is where you want to look for now. I recommend that you look at those accounts and run a projection for a 25% increase in the withdrawal rate the year that Social Security decreases. Check the simulation results of whether or not that increased withdrawal is sustainable for the rest of your retirement years.

So, for example, let's say you're retired and pulling off a 4% withdrawal from your investment accounts. You'll want to simulate a continued 4% withdrawal for the next thirteen years, followed by a 5% withdrawal rate from years 14 onwards until your end of the plan. Ideally, your digital financial plan will be able to project the likelihood of that occurrence being successful. If it runs accurate, then great, but if it does not, then you'll know you'll perhaps want to consider decreasing your withdrawal rate now to compensate for the strain of Social Security thirteen years from now.

Planning for the inevitable drop in Social Security will mean you’ll have extra time to prepare.

Suppose you're not quite retired yet and still working and saving towards retirement. In that case, you'll want to do something similar to ensure you have saved enough for retirement, considering that Social Security may be decreased.

For instance, most individuals know that they should be saving but realistically, how many times have you asked yourself whether you are saving enough to become on track? If you have not, then I suggest you ask yourself the following questions:

At my current savings rate and how much I have saved thus far, what is my projected retirement nest egg at retirement age?

Based on that retirement nest egg number, how much can I reasonably take without running out of money for the rest of my life?

For men, you'll want to project for age 91 and women age 94. I suggest starting with a 4% withdrawal rate and tweaking that higher or lower, factoring in how much you need for retirement income.

So suppose you have estimated you'll want a retirement income of $70k annually. Using your latest SSA retirement benefits statement, see what that projected SSA benefits income will be. Perhaps that number is $30k annually, which means you'll need to pull $40k a year from your nest egg to meet your retirement income goal. A $40k income stream at 4% withdrawal means you'll need a nest egg of $1m.

You'll want to adjust your withdrawal rate in the year Social Security decreases by an additional 0.75% for a total withdrawal rate of 4.75% to account for the 25% reduction in SS benefits.

Running those simulations should give you an idea of the probability of success or not for a retirement that can withstand a reduction in government benefits.

Now I know that doesn't seem very easy, and you may not have the software to run those scenarios. If you're working with a financial planner, those are the questions you should ask your financial planner; that's what you're paying them to do. They should be able to adjust those models for you quickly. If you're not working with a financial planner or your financial planner is incapable of providing you with those simulations or projections, then find someone who can! The Social Security dilemma will not be going away anytime soon, and any financial planner who cannot help you address a reduction in benefits is not worth your time.

You can also create a calculation like that in Excel if you're familiar with the software and comfortable building your own. I used to run these scenarios in Excel back in the day because financial planning software wasn't as capable as they are now. Hence, it's an excellent alternative for those that do not have direct access to robust financial planning software.

Don’t let the unknown derail your plans for a successful retirement. Knowing what the outlook is, good or bad, is better than the unknown.

A prosperous retirement outlook is based on numbers. Yes, there is a genuine and emotional aspect, but the details are in the numbers. How much you have saved and your expected growth rate will determine your probability of retiring in the lifestyle you envision. If the numbers don't come out positively in your favor, well, you know you have two choices: increase that nest egg amount or lower your expectations. Retirement income planning is just that. From my perspective as a financial advisor, it's a matter of whether the math adds up, and if it doesn't, we work on the possible solutions to make things agreeable.

OK, everyone. I know I threw a lot at you. Heck, it was just about everything but the kitchen sink. I told you from the beginning that this would be a lot, and I hope you found value in what I talked about today. The subject of Social Security and retirement income is near and dear to many individuals, and if you have not started working on your plan yet or you need a second set of eyes to make sure your decisions are correct, please let me know.