How the Threat of Insolvency Could Impact Your Retirement Plan
If you haven’t retired, and you’re counting on a specific amount of Social Security income to augment your post-career lifestyle, you probably shouldn’t allocate those dollars, just yet.
That’s because, due to projected future funding shortfalls (estimated to occur in 2034[1]), lawmakers are working behind the scenes to figure out how to keep Social Security solvent without facing a backlash from the electorate.
What are three potential changes to your Social Security horizon?
1) Another Increase to the Full Retirement Age
The earliest you can apply for Social Security is still age 62, but that means a substantial reduction (20-30 percent [2]) in your monthly benefit. It’s hard to believe, but Social Security was once an untaxed income source for retirees, with a full retirement age (FRA) of 65 that remained unchanged for decades.
But with legislation passed in 1983, the FRA began its creep up to age 66 and is now working its way up to 67.
But what if Congress suddenly raises the full retirement age to 68, 69, or even 70?
With longer average lifespans, an influx of millions of additional retirees, and a funding shortfall that’s due to hit in as little as 16 years, a sudden FRA increase could happen.
Make no mistake, raising the FRA to, say, 68, is a two-pronged cut to benefits. That’s because, for FRA filers, it decreases the number of years they’ll receive Social Security. But for those who are willing to wait until age 70 to accrue the extra 8 percent yearly add-on to benefits? It subtracts a full year from that accumulation, as well.
2) The Payroll Tax Cap Could Be Increased or Eliminated
If you have a higher than average income, the tax of 6.2 percent that funds half of Social Security (your employer pays the other half) is levied against the first $128,400 (2018) you earn.
Simply, every dollar you earn after the first $128,400 comes in Social Security tax-free.
Critics of the current cap rate argue that someone earning $120,000 a year is paying a larger percentage of their income in Social Security taxes than a person who earns $250,000 a year.
Proponents of a lower cap rate question why high earners, who as of 2018 can receive a maximum of $2,788 per month [3] (in Social Security benefits), should be required to pay more now and receive nothing extra later.
While steady increases to the payroll tax cap are common, what if lawmakers decide to eliminate the cap altogether, or bump it way up, to, say, $250,000?
Raising the cap amount would certainly pad the fund’s reserves (experts disagree for how long), but the downside, certainly for high earners, is that raising the tax cap is likely to be paired with other changes, specifically, “means testing” (see below).
For high-income earners who are still a few years from retirement, applying the Social Security tax to all (or significantly more) of your income could, over time, result in tens of thousands of extra dollars being deducted from your paycheck that you’re unlikely to ever see again.
[Want to learn more about Social Security? Attend one of our Social Security Workshops.]
3) Means Testing
If you’ve saved well for retirement, concerns about the possibility of future “means testing” that decreases the amount of Social Security you receive, or even disqualifies you from the program altogether, are legitimate.
With its worrisome future balance sheet, new standards for receiving Social Security could be implemented at any time.
When it comes to means testing, there are a number of possibilities, including:
- A reduction in benefits for people with incomes over a certain amount.
- The creation of an asset-based cap (for instance, anyone with total assets over $3 million would be ineligible to receive any Social Security).
As we saw in 2015 with the cancellation of File and Suspend—a popular Social Security filing strategy that gave some qualified retirees tens of thousands of dollars in additional benefits over the course of long retirements—changes such as means testing could be implemented with little or no warning, and have a drastic impact on your retirement income.
[Read: Social Security At Age 62? Why Delaying Your Benefits May Not Pay Off]
Conclusion
While we don’t have a crystal ball, the eventual implementation of some combination of the scenarios listed above seems likely. However, a few things remain certain:
- If you’ve saved well, the additional yearly 8 percent you accrue between your FRA and age 70 may be enticing, but it may not be available in the future.
- Do not base your expected retirement income on today’s projectedSocial Security payouts.
- Save and continue to invest wisely so that your nest egg continues to grow.
Your situation is unique, and your application to Social Security depends on numerous factors. But beware: The closer Social Security gets to insolvency, the more dramatic the changes are likely to be.
It’s important to know your situation. But if you’re not sure what your options are, or you need a second opinion? Contact your Allworth Financial advisor, today.
[1] https://www.marketwatch.com/story/social-security-insolvency-is-now-one-year-closer-2016-07-11
[2] https://www.ssa.gov/planners/retire/applying2.html
[3] https://www.ssa.gov/news/press/factsheets/colafacts2018.pdf
