When a problem is 14 or 15 years away, there’s not great urgency to fix it. But when that problem comes within a decade, that’s a different story.
You’ve likely read that the Social Security trust fund is going to run out of money by 2034, but with the looming Trustees of the Social Security Trust Fund Report coming out soon, it might be more like 2030.
That’s good news and bad news. Good news because it will probably inspire D.C. to enact Social Security reform for the first time since the 1980s, and bad news because the quicker timeline might scare people and cause some behavior change.
Social Security does exactly what it was meant to do, which is provide a floor of income and keep people out of poverty. There are still fewer senior citizens in poverty in the United States than in the general population.
However, the system does need fixes and updates because it’s still based on mortality tables, assumptions and even rates of return that just aren’t up to date anymore. Still, it’s an efficient system that works well for helping Americans achieve a more secure retirement.
My expectation is that the system will always be funded because we’re very reliant on it, but that there might be some cuts and changes.
Looming Cuts, Shifting Behavior
President Joe Biden ran on funding Social Security. One of his proposals during his campaign was to add a payroll tax for people earning more than $400,000 a year. Currently, only wages up to $142,800 are subject to the 6.2% payroll tax that funds Social Security.
From the math side, raising taxes would fix the funding issue, but could create other issues, like potentially politicizing Social Security more than it ever has been.
As we get closer to the date that Social Security may run out of funding, we’ll probably start to see a shift of people not deferring Social Security and claiming earlier because they don’t want to push payments off into the future. Because payments are likely going to be reduced in the future, people feel the need to grab their money today before the government runs out of it.
As we get closer to that benefit cut, I don’t think you’re going to see many people who are willing to defer payments into the future.
Because of this, we’re going to see the math in many of those areas start to shift. If people believe benefits are going to get cut, they get a smaller benefit, and even though the trust fund will still be depleting, it won’t be as quickly.
The decision to claim earlier is going to feel more and more like the correct answer for people because both the math and the emotional parts will align – whereas today, the math misaligns with the emotional part. The emotional part is that you want to claim sooner rather than later, because you want to have your money today, but the math part says most people are better off deferring claiming as long as possible.
Larger Cost of Living Adjustments
One of the most important aspects of Social Security is that it’s a joint life annuity, in essence – it’s a lifetime income stream that has a cost of living adjustment (COLA); it’s indexed for inflation.
Currently, inflation is calculated using the CPI for workers (CPI-W), versus CPI for those 62 and older (CPI-E). While there have been proposals to shift to the CPI-E, this would drain the Social Security trust fund faster, as the CPI-E would have a higher cost of living adjustment due to rising healthcare costs for seniors.
Even though we’re still calculating inflation using the CPI-W, we’re set to see the largest COLA increases we’ve seen in decades in 2022. In 2021, the COLA increased by 1.3%, but in 2022, it could increase by as much as 6.1%, according to some estimates.
Income in the last handful of years has been low, as we haven’t seen a lot of inflation in the CPI-W index until recently. Historically, inflation has been around roughly 3.22%, and reports say today it increased 6.1% before seasonal adjustment, according to the Bureau of Labor Statistics.
Factors to Consider in Claiming Decision
You have to make a Social Security claiming decision at the time you’re going to claim.
Right now, my general feeling is it’s still best for most people to defer payments as long as possible. However, there’s risk associated with that, and you just can’t shrug off the fact that the system is underfunded and on its way to cutting benefits.
So then if you feel conservative, are risk averse and want your money sooner, it might be better for you to claim earlier.
When to claim Social Security is among the most important decisions you’ll ever make. You can’t make this decision in a vacuum.
You should start with understanding what your benefits are and how those are taxed with other income sources. Then consider a variety of other factors, including:
- Inflation
- Your need for lifetime income in your retirement plan
- Diversification of income
- Your other assets and resources
- Risk perspective
- Taxes
- Health and life expectancy
- Spouse’s life expectancy
You have to put all these things together in a plan to make the best Social Security claiming decision for your own situation. If you need help, reach out to your financial professional.
