By Robert Alexandrovic, CFP®, CFA®, CPWA®, Managing Partner
Since the Social Security Act was signed into law in 1935, Americans entering their post-working years have relied on its monthly benefits to supplement their cost of living. Today, approximately 66 million people, or 1 in every 5 residents of the United States, collect benefits from Social Security.
If you were born in 1957, the great news is that you can now join them! But before you do, here are a few things you’ll need to know.
There are three big things to know about updates to Social Security benefits: improvements to the cost-of-living adjustment, increases in the full retirement age, and changes to the taxation of earned income.
- The biggest one is also one of the most positive: the increase in cost-of-living adjustment. In 2023, Social Security benefits increased by 3.2%, which followed a previous annual increase of 8.7% in 2022, and 5.9% in 2021, so beneficiaries today are seeing significant additional increases in their monthly payments that match the cost of inflation. This is a big shift from the previous decade which had low inflation and no increase for the cost of living.
- The full retirement age is increasing. This measure was first implemented in the early 1980s when the retirement age increased from 65 to 67 for those born after 1960. That means those born after 1960 won’t be eligible for their full retirement benefit until they turn 67, and in fact, there are further discussions in Congress that could mean pushing it out even further. More on that below.
- Finally, for current members of the workforce, get ready for some tax hikes! This year, the maximum earnings subject to tax has risen from $160,200 to $168,600. That means every dollar below that level is taxed at 6.2% if you’re employed by someone else. Recall that self-employed individuals are responsible for paying both sides of the tax, or 12.4%, while employers cover half the cost for their employees.
In years’ past, it was common for financial advisors to encourage clients to wait until reaching the age of 70. Doing so was thought to maximize the amount of Social Security benefits they’d receive over their lifetime, as well as protect against the risk of outliving their savings.
For many, that’s still the most logical approach that’s rooted in evidence and analysis. A new whitepaper from the Financial Planning Association confirms that waiting until age 70 provides monthly benefits that are 77% larger in inflation-adjusted terms for those who claim at 70 vs 62; moreover, the analysis showed it was uncommon for individuals investment returns to beat those guaranteed increases by investing in the market.
Of course, there are other nuances for individuals to consider. Each client’s plan is going to be unique so it’s always difficult to provide a blanket recommendation. For example, evaluating one’s family health history and personal life expectancy is important to gauge the right time to start taking your benefits. They might choose to take their benefit early knowing they could receive less over their lifetime if they lived well into their 80’s.
There are also emotional considerations that an advisor should help them put in the context of their financial plan. Some people are afraid their benefits will be lost if not elected early. Others might have anxiety about spending their savings and would prefer to have money coming in to offset their portfolio distribution needs. In both scenarios, taking their benefit early might be the best option for their personal satisfaction if they ultimately have ‘enough’ from other sources to cover expenses late into life.
Each client will require a different solution customized to their financial goals, and an advisor can help walk you through everything to consider before you make the decision.
Individuals today can receive significant annual benefits to the tune of $30,000-40,000 per year.
When accounting for that additional income, Social Security can be woven into an existing investment plan through the lens of an asset. Some people will take the perspective that Social Security benefits act like a bond in that it is safe and secure, thereby allowing them to take more risk in other areas like stocks. In that respect, Social Security can take the place of fixed income or bonds in the portfolio.
Many retirees are also comfortable with their monthly budgets and locked into their cost of living. In turn, this allows them to draw down less from their investment portfolio when supplementing with Social Security. That’s an incredible advantage.
When we plan with clients, we look at the big picture and show them the impact of the timing of their decisions. For example, taking Social Security benefits earlier might lessen the need to pull from their investments. But taking that income early might limit their ability to do Roth IRA conversions or other tax planning strategies. There are lots of possibilities!
Right now, the Social Security Administration projects that the Social Security Trust is going to be depleted in ten years’ time.
When people hear that, they assume that Social Security benefits are going away. That’s not quite true, it just means Americans will have to rely on current tax revenue which would only cover three quarters of benefits. So, when the Trust runs out those same benefits will be marked down by 25% – which will certainly be a significant hit.
Earlier this year, Senators Elizabeth Warren and Bernie Sanders introduced the Social Security Expansion Act, a proposal which would make $250,000 subject to a new Social Security, but only affect 7% of the population and vastly benefit the majority of everyone else. That same bill would also tax business and investment income, creating a surplus – averaging a $240 increase in benefits.
There’s also a bipartisan coalition led by Senators Angus King and Bill Cassidy to push out the benefit age from 67 to 70, and create a sovereign wealth fund that would parse out the investment into other funds, increasing growth potential and relieving some burden from taxpayers. As the debt ceiling negotiations have proved time and time again, any Congressional action remains unlikely until the government hits a breaking point, and a combination of factors will be needed to address the problem.
It’s possible that in the future, means testing for benefits will be required to prove one’s need for full benefits. The influx of Gen Z and Millennials entering the workforce will also help. While it may not be very reassuring for retirees dependent on Social Security as their main source of income, there is good news. As long as people pay into the system, it will fund future generations.
The bottom line is that Social Security benefits aren’t going away, but today’s earners might soon expect to see increases in their taxes to cover the deficit, and current beneficiaries might soon see a reduction in monthly payments.
As you approach your golden years, consider all the factors that might impact your ability and willingness to begin drawing your own Social Security benefits.
Curious about how to navigate your upcoming retirement and the Social Security benefits you may be eligible for? Contact Merit Financial Advisors today for a complimentary consultation.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.