Preparing for the Social Security funding dilemma

This article will ... Lay out the math that is leading to Social Security funding shortfalls. List the possible consequences, like benefit cuts or qualification changes. Note ways to help prepare for possible Social Security changes at different life stages.

Social Security is a mainstay of retirement income and planning for many people. Unfortunately, the program is facing a squeeze on its funding and will likely undergo some major corrective changes in the coming years. Given the uncertainly for those in or approaching retirement — or even younger workers — many should consider ways of lessening their reliance on the program.

“Successful retirement can be a very complicated puzzle of different pieces,” said David Freitag, a financial planning consultant and Social Security expert with MassMutual. “These pieces all have to fit together. It takes time and planning, and, often, workers need help balancing out the pieces and fitting them all together. Social Security is one of those critical pieces in the puzzle, but there are other parts that are needed to make it all work.”

Understanding the problem

Social Security was established in 1935 to provide support for the elderly and disabled. It is funded through dedicated payroll taxes on workers and their employers. In its original form, to collect payments, other than for disability cases, you had to be at least 65 years old.

And that’s the main problem.

• At the time the law was passed, average life expectancy was around 65 years for those who made it to adulthood (the average is five years lower if rates of infant mortality at the time are added in). ¹
• Life expectancy in this decade is around 78 years.²

People are living longer — and are therefore able to collect more Social Security — than when the program was created. Additionally, the baby boom led to a significant increase in the population. So much so that the number of current workers to retirees is steadily declining.

• When the Social Security program was established, there were more than 150 workers for every retiree.³
• In this decade, there are less than three workers per retiree.

While some changes to the program have been made over the years, including adjustments for inflation and when workers can qualify for benefits, the underlying mathematical problem remains the same: Too many people are collecting benefits for too long a time to be sustained by the workforce.

That means the Social Security program will fall short of funding levels needed to sustain benefit payments at their current levels. Indeed, the trustees of the program estimate that will start happening as early as 2033.⁴

What can be done?

A number of steps could be taken to bolster the Social Security system before 2033:

• Reduce benefits. This would mean smaller monthly checks for current and future retirees.
• Extend the retirement age. Full retirement age, where retirees can collect full benefits, has already been raised up to 67 years of age for workers born in 1960 or later. The definition of full retirement qualifying age could be pushed back to 68, 69, or even older.
• Increase taxes. Payroll taxes currently stand at 12.4 percent, split between the worker and employer, up to a certain level of income (roughly $176,100 in 2025, adjusted for inflation). The 12.4 percent tax itself could be increased or the amount of income subject to it could be increased.
• Qualification adjustments. There have been proposals to limit Social Security benefits for affluent households.

All these steps would likely draw intense political debate. Workers who have contributed for years to the program are likely to respond negatively to having age or benefit changes suddenly shift on them. They would likely take out their anger at the voting booth. And it’s this political sensitivity that many believe has led to government inaction on the problem.

Preparing for change

Nevertheless, the math is such that Congress must take some action in the next few years. And that action is likely to involve some or all of the steps above. So how do you prepare?

For the younger set, establishing and maximizing your retirement savings is essential. This will help set you up for retirement security, regardless of what happens with the government program.

• Start early. The earlier you start, the more the math of compounding returns works in your favor.
• Take advantage of qualified retirement plans. These allow for tax-advantaged savings.
• Consider risk and reward. Investigate what type of investments may be suitable for your risk profile.

For those approaching or just entering retirement, you should consider:

• Taking advantage of catch-up provisions. Some qualified plans allow for more contributions in your later years.
• Diversifying retirement savings. Ideally you should have a diversified portfolio that may include qualified retirement savings plans as well as investment accounts.
• Using annuities and life insurance. Annuities can provide guaranteed retirement income. Permanent life insurance can help supplement retirement income as well.
• Perhaps delaying Social Security benefits? The longer you wait to file for Social Security benefits, the greater your benefit check will be. Of course, this makes sense only for those who expect to live a long time. Those with shorter life expectancy due to health or family history issues may want to start collecting earlier.
• Weighing a longer working life. This might involve pursuing continuing education, acquiring new skills, or transitioning to less physical roles as retirement approaches. Or perhaps turning a hobby into an enterprise.

Conclusion

Social Security’s funding problem means Congress will have to change aspects of the program. How much will change is unknown, but it is likely to have a significant impact for future retirees. As David Freitag noted above, these are pieces of the income planning process. By diversifying retirement savings, planning for longer careers, and considering Social Security benefit filing strategies, those approaching retirement can fine-tune the pieces to better prepare for whatever changes may come. Some people opt to talk with a financial professional to help with planning and thinking through some of the options for relying less on Social Security.

Discover more from MassMutual …

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