Here we go again: The recently released 2021 Social Security Trustees’ report found that the Social Security Trust Fund is once again nearing insolvency. By 2033, there will only be enough revenue to pay 76% of scheduled benefits.
For many of us, this will be the second time in our lifetime that the government will need to change the rules, and the Social Security payments we were promised in retirement are facing another potential reduction.
One thing is clear: It’s a mathematical certainty that Social Security must change. In fact, according to the estimates forecast in the 2021 Social Security Trustees’ Report, in the five minutes it will take for you to read this article, the federal government will make $25 million in promised Social Security benefits that it cannot keep.
From its origins, Social Security has struggled to balance the amount of revenue brought in via payroll taxes versus the amount paid out in benefits. The very first recipient of Social Security retirement benefits, Ida Mae Fuller, paid $24.75 into the program yet received $22,888.22 back in the form of retirement benefits, for a return on investment of 92,380%.
And the imbalance has grown over time: In 1950, there were 16.5 workers for every retiree receiving benefits. By 2020, that ratio had fallen to 2.7, and is expected to continue falling to 2.3 by 2035.
In 1982, the first time the trust fund faced insolvency, Congress had to pass emergency legislation to allow the Social Security Administration to borrow money to continue to make full and on-time payments to its recipients. In a failed attempt to fix the program for the long term, a bipartisan compromise was reached between the Reagan administration and a Democratic-led House of Representatives.
The result was an increase in payroll taxes and a decrease in benefits caused by a gradual increase in Social Security Full Retirement Age from 65 to 67. These fixes were supposed to keep Social Security solvent for 65 years but, their solvency estimations now have fallen short by almost 2 decades.
It is no wonder, then, with this newest Social Security funding crisis looming, that Americans do not trust that the government will keep the promises they had made. In fact, according to the 2021 Social Security Confidence Survey, 70.71% of Americans age 45 and older are concerned that they will not receive their full Social Security benefits as promised to them.
As advisors, what can you do to help alleviate your clients’ concerns?
First, you need to recognize that the problem starts now, with 2021 being the year that the Trust Fund will begin to deplete. We’ve known about Social Security’s funding imbalance for decades, but we’ve always been able to set it aside as a far-off problem that we hope the government will fix.
That way of thinking no longer works: The trust fund’s insolvency is a near-term crisis, and government gridlock is at an all-time high. Advisors must be prudent, be prepared and pay close attention to the financials of the Social Security program to ensure their clients maintain their lane on the road to financial success in retirement.
Second, your clients understand the importance of Social Security, but they need your help in framing how Social Security fits into their overall financial plan. Throughout their retirement years, the average household will receive an estimated $945,000 from Social Security. A higher-earning household can easily receive more than $1.6 million in benefit payments. A reduction to those cashflows would significantly impact most retirees.
Even for wealthier clients, who may say they are not counting on Social Security anyways - they didn’t attain their level of wealth by letting hundreds of thousands of dollars walk out the door. Although many Americans are counting on Social Security in retirement, many of them do not have a plan to address a shortfall from Social Security and the longer they wait, the more likely they are to have less money than they planned in retirement. As a financial advisor, you have a fiduciary responsibility to help your clients mitigate risks of this nature.
Finally, your clients will look to you for guidance on how Social Security changes could affect them. Consider the following possible changes Congress could make.
Proposed fix #1 for Social Security: Increase in full retirement age.
For example: A client who is 55 years old and has worked hard to save for retirement. He wants to maximize his Social Security but does not want to work past age 67. A move in full retirement age to 70 would disrupt his plans because this change would cause him to see about 20% less of his lifetime benefits from Social Security at a time when he will need the income the most.
Proposed fix #2 for Social Security: Means-testing of benefits.
Imagine a client who is 72 and a widow. She has a good retirement income, but reductions would hurt the lifestyle that she worked so hard to build. She worries that means-testing of Social Security may impact her because a reduction in her Social Security income would exacerbate other risks to her retirement income, such as longevity and sequence of returns risks.
She is already one of the 5 million Americans means-tested by Medicare, and recently she was ineligible to receive COVID-19 Economic Impact Payments due to her level of retirement income. Means-testing is a tool frequently used by the government and it is clearly here to stay.
Proposed fix #3 for Social Security: Temporary or permanent benefit reductions.
For this example, let’s look at a married couple that will depend on Social Security as part of their retirement plan. If the forecasted 24% reduction were to be implemented, as a couple they could see a reduction of approximately $1,491 per month. Even an 8% decrease would result in a loss of nearly $500 a month.
Understanding the problem and the potential rule changes that could take place allow financial advisors to build a plan to mitigate that risk. As is the case with most retirement risks, annuities can be a tool that advisors can use to mitigate that burden.
Annuities offer tax-deferred growth and principal protection, giving clients options and flexibility where traditional asset classes might not, due to market timing. And, unlike in 1982, this time there are annuity solutions that provide special liquidity and account value bonuses triggered by Social Security changes.
Take Mary, for example. She is 65 and has $100,000 in a low-yielding bank certificate of deposit maturing soon. Her goal with this money is to keep her principal safe and earn a guaranteed return, but Mary is concerned that a reduction to her Social Security benefits would cause her to dip into her savings in order to maintain her lifestyle.
By repositioning this asset into a fixed annuity with Social Security protection, you can help Mary achieve all her goals. She will have peace of mind that her principal will be protected, she will continue to grow her money with a guaranteed rate, and if her Social Security benefits are reduced, she’ll receive a bonus to avoid having to draw down her savings.
Beginning the conversation with your clients about protecting their promised Social Security benefit amount is as easy as these three steps:
Review their Social Security statement with them and ask how the projected reduction would affect them.
Discuss the facts and calm their concerns that Social Security will disappear entirely. It will still be there for them, but not in the way we all planned for it to be.
Show how repositioning patient money into an annuity with principal protection, tax-deferred growth and Social Security protection can help keep their retirement income goals on track.
No matter what fix Congress may approve, if clients and financial advisors begin to have these conversations, both parties will feel the most prepared for what is to come with Social Security. I believe that if we empower financial advisors with new tools to be able to say, “We have an answer for that,” we can change financial planning.