Is Social Security Going Bankrupt? How does that Impact My Retirement Plan?
By: Brian Seay, CFA
Why should you care about social security? For most people, social security payments will make up a substantial portion of their retirement income after paying into the program for their lifetime. For higher net worth individuals that have other assets, the maximum social security payout from full retirement age to just 80 years old is more than $750,000. So regardless of your situation, social security represents significant economic value to you during retirement.
As we move into political silly season, Social Security will become even more of a political hot-potato. Undoubtedly, one side will accuse the other of “pushing grandma off a cliff,” conversely one side will suggest the other is “driving the program to bankruptcy.” Social Security garners lots of hot takes, not all of which are correct. So here, my goal is to lay out how social security works, where the program is likely headed and what that means for participants both now and in the future. Lastly, we will talk about how you should plan for social security, regardless of your income level.
First, understand that social security does not work like your 401k. When you save, you accumulate enough assets to hopefully live off the earnings or interest of those assets down the road. There are not enough assets in the Social Security Trust Fund to pay benefits based on interest received from assets. The total value of the Trust Fund is $2.8 trillion dollars. Even at today’s high interest rates near 5%, the Trust fund itself could only produce income around $140 Billion, which would cover only 10% of the 2023 benefit payout.
Social Security is an income transfer program. In 2023, Social Security received $1.35 trillion dollars from your payroll taxes. The program paid out $1.39 trillion dollars in benefits. The Trust Fund covered the $41 billion dollar gap between the taxes received and benefits paid.
The total value of the trust fund is $2.8 trillion dollars. For the last several years, tax receipts have not covered the required social security benefit payments. The government dipped into the trust fund to make benefit payments. Currently, this is expected to continue until the trust fund is depleted in 2035.
Are those stats real or political talking points? Those statistics come from the Trustees report directly from the Social Security Administration. They use a very complex actuarial model, like other pension funds and insurance companies, to build projections. Will the future play out exactly like the forecast? No. But the actuarial forecast is the best view we have of all the interrelated data points that make up both contributions to and benefit payments from the program. Actuarial science is generally very good, as evidenced by the fact that most insurance companies make profits each year. In addition to the Social Security Trustees report, the Congressional Budget Office does an independent analysis of Social Security. Their results are more draconian. The trust fund runs out in 2032 instead of 2035. So regardless of your economic views and assumptions, the data shows that the current program is not on a sustainable path and something must change.
That change will impact you. Regardless of your politics, one of four things must happen between now and the mid-2030s.
Economic growth and payroll taxes must be significantly above trend for many years. This is very unlikely to occur and significantly higher wages likely results in higher inflation, which drives up prices and COLA adjustments for Social Security.
Social Security Benefits are reduced to align with the payroll taxes received.
Taxes are increased to fund benefit payouts.
The government changes the law and simply borrows an extra $300 billion dollars each year to fund the program. This likely results in higher interest rates, which is not good for long-term economic growth.
So is social security going “bankrupt?” Not in the traditional sense. If nothing happens between now and 2035, the current law imposes benefit reductions that bring benefit payments in-line with tax receipts. That leads to approximately a 20% reduction in benefits. The program doesn’t go bankrupt, but everyone’s benefits receive a dramatic haircut to force sustainability.
Your politics might dictate your preferred solution to the shortfalls in the program. However, all the likely outcomes impose a tax on Americans in some way. Benefits are reduced, taxes are increased, or inflation is higher.
So how do we plan now that we understand the facts around Social Security?
First, our view is to take a conservative approach to long-term planning around social security. Given the state of the program, relying heavily on current benefit levels seems irrational.
If you are younger, I think assuming that your benefits will be reduced significantly, or that your taxes will be higher, makes sense. Either of those outcomes means you need to save more of a smaller amount of future income.
For those in their 50s, all the realistic political solutions seem to protect benefits for all but the very highest income earners. But that money must come from somewhere, likely through higher taxes. So I would consider incorporating slightly higher long-term tax rates into your planning. Higher long-term rates mean you should consider ROTH conversions, charitable giving strategies, real estate ownership and other strategies to reduce your long-term taxable income.
Lastly, a word on the timing of Social Security Distributions.
One of the most common questions we receive from clients is “what should I take social security?” The answer is different for everyone, but one of the big myths is that everyone is better off by delaying benefit payments as long as possible. It is true that by delaying payments, your payments from Social Security will maximize the value you receive from the program. However, if you don’t live into your mid-80s, you may not break-even on the decision to delay benefits in your 60s. Additionally, if you are withdrawing significant dollars from a 401k or a traditional IRA as opposed to receiving benefits, you should consult an advisor. The compound effect of paying taxes and reducing growth may make you worse off than if you had just taken benefits early. It depends on your specific situation and goals. So don’t fall into the trap of just assuming a delay is the right course of action for you.