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Mark Miller: Remaking Retirement

Should You Count on Social Security?

The answers depend on your age.

Will Social Security be there when it's time for you to retire? You wouldn't think so if you listen to deficit hawks and Beltway media.

They'll tell you that Social Security is at a "tipping point," because the program is paying out more than it takes in. Or that the Social Security Trust Fund is broke. Or that Social Security is "sick and getting sicker."

No wonder, then, that a Gallup poll last year found 60% of Americans don't expect Social Security to pay them benefits when they stop working. The worries are especially acute among younger people: 77% of 18- to 34-year-olds told the pollsters that Social Security is either in a state of crisis or has "major problems."

Social Security isn't a direct cause of the federal deficit. But policymakers do need to address a problem down the road in 2035, when the program's huge surplus will be exhausted from paying out retirement funds to the boomer generation; at that point, it would have enough funds from current revenue to pay about 78 cents on every dollar of promised benefits.

Neither political party has yet put forward a specific Social Security reform plan to fix that problem, although President Obama might yet embrace the recommendations of his own National Commission on Fiscal Responsibility and Reform, which call for long-range benefit cuts via higher retirement ages, lower cost-of-living adjustments, and a more progressive benefit formula.

Social Security isn't going away anytime soon, and it's highly unlikely that reforms will impact today's seniors or boomers nearing retirement. But Americans in their early 40s and younger are right to worry about Social Security's future. What's more, the program already is becoming less valuable for all Americans as a result of major changes enacted by Congress back in the 1980s.

How confident should you be about Social Security? What role should benefits play in your retirement plan? The answers depend on your age.

Social Security 101
First, let's separate myth from reality on Social Security's financial condition, relationship to the national debt, and its role in the economy.

Social Security had a $2.5 trillion surplus in 2009, a number that will hit $3.8 trillion in 2020 before it starts falling again as boomer retirements accelerate, according to the Economic Policy Institute, a progressive think tank focused on the economic condition of low- and middle-income Americans and their families.

Social Security isn't a cause of the deficit, and the surplus is not an illusion. Social Security critics often deride the surplus as no more than worthless I.O.U.s from the U.S. Treasury owed to the Social Security Trust Fund (SSTF). That's false. The surplus is invested in a special type of full-faith-and-credit Treasury bond that the federal government must repay to the SSTF. The government has, indeed, spent what it borrowed from the SSTF--what other reason would it have for borrowing the money?

So, what is a huge surplus for the SSTF is a big long-term liability of the U.S. Treasury--but no different than the debts we owe to bondholders in China or anywhere else in the world.

Social Security's current cash flow negative status isn't a surprise, or a worry. Last year, Social Security began paying out more than it is taking in. That was always expected to occur as the giant boomer age wave started drawing benefits from the surplus, but it happened a couple of years earlier than expected due to the severity of the recession.

Social Security is not overwhelming the U.S. economy. Benefits are equal to 4.9% of gross domestic product (GDP), and will rise to just 6.2% in 2035, when all baby boomers will be 65 or older. After 2035, Social Security expenditures are projected to stay around that percent of GDP through 2085.

Why Social Security Matters
It's difficult to overstate the role of Social Security as a key source of retirement security. The program's monthly benefits will be the most important--and only--source of guaranteed income for most retirees: 40% on average.

For many seniors, Social Security will be the only source of inflation-protected guaranteed income--by law, benefits are adjusted annually according to a cost-of-living formula tied to one of the government's key measures of consumer prices (CPI-W). That makes it an invaluable tool in combating longevity risk--the risk that you'll outlive your money.

Social Security also provides critical protection to elderly women, who outlive men and tend to bring fewer assets into retirement due to lower lifetime earning histories. The program is the sole source of income for 42% of single women over age 62, according to the AARP Public Policy Institute.


Why Social Security Is Becoming Less Valuable
But Social Security already is on track to be less valuable in the years head, even if policymakers don't make further cuts.

Social Security was revamped in 1983 to avert a financial crisis, and in anticipation of the boomer retirement wave. The most important change was a gradual increase in the age when seniors could file for full benefits--the so-called Normal Retirement Age (NRA). The reform package set in motion a gradual increase in the NRA, from 65 to 67 for people reaching that age in 2022. At that point, monthly benefits will be about 13% smaller than they would had the retirement age stayed at 65, according to the National Academy of Social Insurance, a nonprofit, nonpartisan research and policy organization made up of many leading national experts on social insurance.

The higher retirement age is an across-the-board cut in your monthly benefit check--no matter when you retire--due to the program's design around the NRA. Benefits are reduced if you file before your NRA, and increased if you file later than that date. The idea here is to provide roughly the same lifetime benefits regardless of claiming age.

Here's an example of what happens when the NRA rises. If you were born between 1943 and 1954, your full retirement age is 66. "If you decided to take benefits early at 65, you would no longer get a full benefit, but a fraction of a full benefit," explains Virginia Reno, NASI's vice president for income security. "On the other hand, by waiting until 66, you used to get more than a full benefit when the full retirement age was 65--now you don't."

The 1983 reforms also added new taxes on Social Security benefits and a small delay in cost-of-living adjustments; all told, the package cut amounts to a phased-in benefit cut of 20%, according to NASI.

Rising Medicare premiums are also eating away at Social Security's value. Medicare Part B (outpatient services) usually are deducted from monthly Social Security payments. With health-care costs soaring, those premiums are scheduled to jump from 6% of benefits for someone retiring as recently as 2003 to 9% for someone retiring in 2030, according to the Center for Retirement Research at Boston College (CRR).

The net effect: Social Security will replace a smaller share of pre-retirement income over time. CRR has compared replacement rates for an average earner who retires at age 65 in 2002 and 2030; its forecast shows that replacement rates will fall from 41% to just 29% (see chart below).

How to Maximize Your Benefits
The best way to combat Social Security's falling value over time is to make sure you maximize your own monthly payouts. How? By waiting at least until your NRA if at all possible.

 Full Benefit Age by Year of Birth
Year of Birth Year Age 62 Full Benefit Retirement Age
1937 or earlier 1999 or earlier 65
1938 2000 65 and 2 months
1939 2001 65 and 4 months
1940 2002 65 and 6 months
1941 2003 65 and 8 months
1942 2004 65 and 10 months
1943-54 2005-16 66
1955 2017 66 and 2 months
1956 2018 66 and 4 months
1957 2019 66 and 6 months
1958 2020 66 and 8 months
1959 2021 66 and 10 months
1960 or later 2022 or later 67
Source: National Academy of Social Insurance.

Monthly benefit payments are 8% higher for every year you wait up until age 70 (see chart below). That can really add up over time; if you wait until age 70 to claim benefits, your monthly income will be about 76% higher than it would be if you had claimed benefits at age 62.

 Monthly Benefits Are Higher If You Wait (example for person eligible for $1,000 at full benefit age of 66)
 If Benefits Start
 at Age:
Amount ($)
Percent Increase Over
Age 62 Amount
62 750 -0-
63 800 7%
64 866 15%
65 933 24%
66 1,000 33%
67 1,080 44%
68 1,160 55%
69 1,240 65%
70 1,320 76%
Source: Social Security Administration 2008, National Academy of Social Insurance.

Many workers worry that they'll clip their lifetime payouts by waiting. But Social Security's most important function is to protect you from longevity risk--that is, the risk of running out of money in advanced age, when work probably isn't an option, pensions may be eroded by inflation, and savings may be depleted.

"Your lifetime benefits depend on how long you live--but no one can know that," Reno says. "The right question is, 'How do I protect myself against reaching age 95 with no savings left and an inadequate Social Security benefit?"

And for married couples, if the higher earner is the man, it's especially important for him to wait to file as long as possible. Women usually outlive men; Social Security's survivor benefit allows a widowed spouse to receive 100% of her husband's benefits.

You can run a "what-if" analysis on your own benefits using the Retirement Estimator at the website of the Social Security Administration (SSA).

Discounting Social Security's Value
Should you discount Social Security's future value in your retirement plan? That depends on your age.

Current retirees and workers within 10 years of their NRA can count on receiving 100% of their benefits, since the Social Security Administration's current projections include all the adjustments from the 1983 reforms. And no one proposing more changes to the system advocates changing benefits for today's seniors or those near retirement.

Many financial planners advocate a conservative approach for younger workers. Since Social Security currently can promise to pay only 78% of benefits past 2035, many discount future benefits on the assumption that no deals will be reached in Washington to repair that problem.

"If the majority of a client's retirement years are projected to be after that date, I use that information," says William Duncan, an independent financial planner in Henderson, Nev.

Laura Scharr of Ascend Financial Planning in Columbia, S.C., discounts projected client benefits based on different age brackets. "For clients over 60, I assume 100% of benefits, but only a 1% COLA, vs my overall 4% inflation assumption," she says. For clients over age 50, she assumes 75% of benefits, and 50% for those over 40. "If a client is under age 40, I assume nothing unless they're in a lower socio-economic bracket."

But even affluent clients need to consider longevity risk, says Mark Balasa of Balasa, Dinverno Foltz, a private wealth management firm serving high net worth clients. "Even some of our clients with $1 million or more of investable assets can use up those funds because of their spending habits," he says. "So if you run a plan for them without Social Security, they don't have enough to make it to their life expectancy."

Mark Miller is a retirement expert and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living. The views expressed in this article do not necessarily reflect the views of