I hear this from every one of our clients planning for retirement. Given the unsustainable trajectory of our federal government’s spending, we must assume that a program accounting for over 20% of the federal budget, and facing a demographic tidal wave, will not escape reform.
If you think in terms of budget basics, solutions can be separated into those providing more revenue to the system, or demanding less benefits of it. Following are some policy discussion references and our ideas.
Social Security derives its revenue from a 6.2% payroll tax (12.4% for those who are self employed), applied to earnings below a wage cap (currently $106,800).
Janemarie Mulvey, of The Congressional Research Service, conducted a study examining the effects of eliminating the cap on earnings subject to Social Security taxes. At the time of the report, her research indicated that “if the maximum taxable earnings amount had been raised in 2005 from $90,000 to $150,000 (roughly the level needed to cover 90% of all earnings) it would have eliminated roughly 40% of the long-range shortfall in Social Security”.
Most schemes for reducing benefits exempt those closest to retirement, and separate classes of recipients into low or high income earners.
Andrew G. Biggs, in a recent article for the American Enterprise Institute, explains the basic demographic trend behind rising Social Security liabilities, and argues generally for increasing the retirement age. In a well documented study from last year, David John of the Heritage Foundation lays out a specific plan to raise the normal retirement age from the current age 67 to age 68, and the early eligibility age from 62 to 65, reflecting the same process used in 1983 that established the current framework.
Means testing refers to a reduction in benefits for wealthier retirees. In a well reasoned study, Dean Baker and Hye Jin Rho for the Center for Economic and Policy Research, assert that for means testing to have any meaningful effect on Social Security’s bottom line, it would have to expand its reach beyond the affluent to middle income Americans. Robert C. Pozen of the Brookings Institution proposes a way to protect middle income earners through federal government “matching” of their retirement savings.
In helping our clients plan for their own retirement, we try to foster an understanding of how various factors will impact them financially. For example, delaying retirement will generally enhance your finances because you will have saved for a longer period and presumably need retirement income over a shorter period. Conversely, if you assume that your investments will generate 10% per year, your income would be negatively affected if portfolio returns average only 5% annually. In short, there is a range of possible outcomes in retirement planning, all bound by an evolving reality. Prudence suggests using conservative assumptions.
Clearly, the Social Security system is not sustainable on its current course; it does not reflect what we recognize as “reality”. General proposals for fixing the problem include raising taxes and reducing benefits. My personal guess is that the solution will include some of each; an increase (but not elimination) of the wage base, and a systematic increase of the retirement age, perhaps ultimately to age 70 for full retirement and age 65 for early retirement. Regardless of the solution, we can be assured that the longer it takes to develop a solution, the stronger the necessary medicine; in short, sick but curable, with an unpleasant road to recovery.