Following the theme of last week's post, one of the things I find interesting about the Social Security program is how similar the fundamental funding issues are to those faced by folks planning for, and living in, retirement. Even the methods used for long-term analysis are similar. So, let's dig a little deeper into the Social Security funding conundrum and look at some of the key issues from a retirement planning perspective.
While there is lots of information available regarding Social Security, my preference is to go right to the source. Fortunately, it's easy to find information right on www.ssa.gov, such as The Future Financial Status of the Social Security Program, a good descriptive piece written by the program's chief actuary. The language is a little dense and dated (from 2010), but the content is good and important. Another is the annual report to Congress from the trustees of the Social Security program.
The sense I get from reading both documents is something like watching a slow-motion train wreck. But it's not all doom and gloom since there are known solutions to the problems.
I'm going to include some quotes from the 2010 document and excerpts from last summer's trustee report, so this post might be a little longer than usual. Links to each of these documents are below if you're looking for a little light reading.
Like your humble financial planner, the people who run the Social Security program do a lot of forecasting. They determine whether current savings and expected cash flows are enough to allow a certain amount of future spending. They make assumptions about how much income will come from investments, how long people are likely to live and how much income people are likely to generate while still working. And these calculations aren't done once and then forgotten about. They are run frequently as the variables change.
As you might imagine, the analysis looks at the numbers from a variety of angles and timeframes. The Future Financial Status paper says the annual report needs to be a "finger on the pulse of the program", updating Congress on the status of the program for the past year, the next five years, and provide an actuarial analysis covering the next 75 years. The latter is supposed to provide "early warning" indicators of longer-term problems for the trust fund that pays out the money.
This longer-term forecasting is like analyzing plans for retirement. And any of you who have done retirement planning with me would remember the Monte Carlo simulations and the "Probability of Success" meter. A similar approach is used by the Social Security Administration to test long-term sustainability.
Interestingly, the math would be simple, and the fancy testing wouldn't be as necessary, if there was a huge supply of money (Treasury bonds) allocated to pay for Social Security in perpetuity. The bonds would simply pay interest and the interest payments would be sufficient to cover costs. How much would the trust fund need now to enjoy this state of Nirvana? At least $12.5 trillion. Since this isn't possible today, we need to use different income sources and more advanced analysis.
Just like in our retirement planning, randomized trials are performed (in this case 5,000 whereas we run 1,000) trying to simulate a wide variety of potential outcomes based on assumptions for birthrates and life expectancy, income from payroll taxes, interest payments from the Treasury bonds, and many other metrics.
How does the trust fund look during these long-term projections? In short, there's enough money to cover expenses for the near future but, over the long-term we can hear the train a'comin, so to speak.
Why? Future spending is projected to exceed income and, just like living in retirement, you can only go so long dipping into principal before something has to give. From last summer's report to Congress (italicized, emphasis mine):
A quick explainer – OASDI stands for Old Age and Survivors Insurance and Disability Insurance, and "intermediate assumptions" is the middle-of-the-road, or best estimate, out of three sets of assumptions.
The reserves of the combined OASI and DI Trust Funds along with projected program income are adequate to cover program cost over the next 10 years under the intermediate assumptions.
Reserves increase through 2021 because annual cost is less than total income for 2017 through 2021. Beginning in 2022, annual cost exceeds total income, and therefore the combined reserves begin to decline, reaching $2,607 billion at the end of 2026.
Under the Trustees' intermediate assumptions, projected OASDI cost will exceed total income by increasing amounts starting in 2022, and the dollar level of the hypothetical combined trust fund reserves declines until reserves become depleted in 2034.
How can that be the case when you just read that by the end of 2026 the trust fund is projected to still have $2.6 trillion dollars? The program is expecting to overspend by at least that much in subsequent years.
Projected OASDI cost increases more rapidly than projected non-interest income through 2037 primarily because the retirement of the baby-boom generation will increase the number of beneficiaries much faster than the number of covered workers increases, as subsequent lower-birth-rate generations replace the baby-boom generation at working ages. [Current birthrates in the U.S. are at 1.9 per household compared with over 3 during the "Baby Boom" following WWII and the longer-term average of 2.7 – fewer workers funding more beneficiaries.]
The trustee report goes further...
The projected OASDI annual cost rate increases from 13.41 percent of taxable payroll for 2017 to 17.02 percent for 2038 and to 17.80 percent for 2091, a level that is 4.48 percent of taxable payroll more than the projected income rate (the ratio of non-interest income to taxable payroll) for 2091.
Think of this like the so-called "4% rule", generally thought to be a sustainable withdrawal rate from one's portfolio during retirement. Exceed this amount by a little and you're dipping into principal. Exceed it by a lot and you're shoveling coal into the train's engine as it speeds toward the cliff. How much is a lot? Well, it's depends. What to do about it? Well, that also depends.
To illustrate the magnitude of the 75-year actuarial deficit, consider that for the combined OASI and DI Trust Funds to remain fully solvent throughout the 75-year projection period: (1) revenues would have to increase by an amount equivalent to an immediate and permanent payroll tax rate increase of 2.76 percentage points (1) to 15.16 percent, (2) scheduled benefits would have to be reduced by an amount equivalent to an immediate and permanent reduction of about 17 percent applied to all current and future beneficiaries, or about 20 percent if the reductions were applied only to those who become initially eligible for benefits in 2017 or later; or (3) some combination of these approaches would have to be adopted.
Just like with retirement planning, you can charge ahead with a plan that's not expected to work and hope for the best. Or you can change your plan.
If substantial actions are deferred for several years, the changes necessary to maintain Social Security solvency would be concentrated on fewer years and fewer generations. Much larger changes would be necessary if action is deferred until the combined trust fund reserves become depleted in 2034. For example, maintaining 75-year solvency with policies that begin in 2034 would require: (1) an increase in revenues by an amount equivalent to a 3.98 percentage point payroll tax rate increase starting in 2034, (2) a reduction in scheduled benefits by an amount equivalent to a 23 percent reduction in all benefits starting in 2034, or (3) some combination of these approaches would have to be adopted.
It's interesting to note that the Future Financial Status paper from 2010 contained basically these same recommendations, except the deficit numbers were smaller then. Time was not on our side.
I think we'd all agree that delay is not an option and that problems tend to worsen if ignored. Fortunately, potential fixes for Social Security's funding problems are presented to Congress annually, so they'll know what to do when the political will exists to do so.
The takeaway for your own retirement planning, aside from being concerned about the long-term viability of a chunk of your retirement income, should be to not be cavalier about early warning signs that pop up in your plan. After all, the government can always raise taxes whereas your only equivalent option would be to go back to work. Yikes.
Have questions? Ask me. I can help.
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