Planning for Social Security Uncertainty

I have a client who is nearing retirement as a self-employed gardener. At age 67, she doesn’t have a massive amount of retirement savings. But she has paid into Social Security her entire working life, and her projected benefits are expected to cover more than half of her expenses in retirement.

Overall, Social Security accounts for about 30 percent of aggregate income for individuals ages 65-plus. For those in lower income brackets, it represents a substantially larger share. Even for wealthy people, Social Security can be instrumental in creating a sustainable retirement plan (“sustainable” meaning the person/couple can maintain a certain living standard throughout retirement).

But Social Security’s financial status is troubled, to say the least. This year’s Social Security Trustees Report showed that the projected depletion date for the retirement trust fund moved from 2033 to 2032, at which time the program will be able to pay only 78 percent of scheduled benefits. This 78 percent of promised benefits will drift gradually lower over time due to the aging of the population (more retirees relative to workers).

Lawmakers have floated a range of fixes such as raising the payroll tax cap, gradually raising the retirement age, or means-testing benefits. It’s possible they could act before 2032 to close some or all of the gap. But even if Congress acts, it will still mean a benefit cut and/or a tax increase (note that some people – such as retirees – may be exempt from the changes). How, then, should we evaluate and react to this risk?

Throughout life, we face an array of financial risks. In general, there are four ways you can handle them. For example, let’s consider a car-owner who faces the risk of totaling his vehicle and needing to replace it.

He could avoid the risk by not driving at all. He could retain the risk, simply accepting that he might have to replace the car if he crashes it, without specifically planning how to cover the cost. He could reduce, or hedge, the risk by setting aside money in a savings account in case of an accident. Or he could transfer the risk to an insurer for an annual premium.

With these concepts in mind, how should our financial plans address the risk that Social Security might not be as much as we planned?

The most common strategy I’ve seen is to retain it (avoidance is not an option here). Most people simply accept that their Social Security benefits might be lower someday but without specifically changing their behavior. In general, I think most retired people are right to accept this risk. It seems unlikely, though not impossible, that Congress will reduce benefits for people who are already receiving them.

But for those who are not yet retired, the risk is more acute. It is nearly certain that there will be some reduction of benefits and/or increase in taxes for people under a certain age. Retaining this risk could mean disrupting an otherwise stable retirement plan.

An alternative would be to hedge this risk by working longer and/or saving more. This option may not be palatable for many, but it may be prudent given the possibility that a sizable reduction in Social Security benefits could derail their plans.

There’s also a more specific strategy for hedging this risk: delay claiming. Waiting from 62 to 67 increases your monthly Social Security benefit by more than 40 percent, and each additional year until age 70 adds another 8 percent. This is likely a larger, more reliable boost than almost any alternative financial product. Delaying usually means drawing down savings or continuing to work, but for someone who can manage that, it directly offsets the risk of a future cut.

Finally, for those who need to feel confident that their guaranteed income will be above a certain level, they could choose to transfer some risk by purchasing an annuity product. I don’t typically use annuity products in my practice, but for certain risk-averse retirees, they can provide peace-of-mind.

Practically speaking, one way to assess whether additional working years are necessary is to create a retirement planning projection. Financial planners use complex software, but you can also build a barebones version yourself with a spreadsheet or an AI tool. Such a plan compares your projected expenses with sources of income and retirement savings to determine how much you’ll need to withdraw to cover your costs for a given lifespan.

Once you’ve put together this plan, you can run alternative scenarios, such as “what happens if Social Security gets cut by 20 percent?” How much does this impact the withdrawal rate on my other assets? Does it still look sustainable?

Retirees with substantial pension income, savings, or low spending needs may find that a Social Security cut doesn’t meaningfully threaten their plan’s sustainability. But retirees that are more reliant on Social Security for the lion’s share of their retirement spending should likely consider options to deal with this risk.

The point isn’t to predict exactly what Congress will or won’t do. But, regardless, it would be prudent to treat Social Security benefits as a variable number and to develop a financial plan that is sturdy enough to hold up even if that number comes in low. Consider building a baseline plan that lowers your projected benefit by 20 percent, and see whether it is still viable. If your plan can absorb the risk, great. But if it can’t, consider working a bit longer, delaying when you claim benefits, or saving a little more. These strategies will be necessary regardless of what Congress does, because resolving the Social Security shortfall in the end will still include reduced benefits and/or increased tax revenues that could affect you.

Luke Delorme, CFP® is Director of Financial Planning at Tableaux Wealth in Great Barrington, MA (www.tableauxwealth.com), reachable at luke@tableauxwealth.com. To stay current on the Squared Away blog, join our free email list.

This blog post is for informational and educational purposes only and should not be considered financial advice. Consult a qualified professional for advice specific to your situation.