The Social Security Administration (SSA) is no stranger to doomsday predictions.
After every market scare or economic wobble, many have nervously wondered if they could count on Social Security as a regular and expected source of retirement income.
But over the years, the pay-as-you-go system has chugged along predictably. That is, until the COVID-19 pandemic inflicted a financial shock that brought severe financial strain to an already scrutinized organization.
With several news headlines seeking to prepare taxpayers for the worst, the big question is:
Can you count on Social Security for your retirement plan?
How the Pandemic Hurt Social Security
There doesn’t seem to be a facet of modern life the pandemic hasn’t impacted, and Social Security certainly hasn’t been immune.
And yet, the problems with Social Security weren’t solely caused by the pandemic; instead, COVID-19 merely exacerbated them.
To better understand why Social Security has a money problem, let’s quickly refresh how the system works.
Social Security, the Early Years
At its inception in 1935, Social Security was a system designed to provide financial assistance to retired workers. But it’s come a long way from its nearly 100 years of existence.
Through the decades, it’s since grown to be one of the largest economic systems in the country, serving roughly 65 million people a month (as of 2021) and costing a hefty trillion dollars in benefits per year.
Social Security benefits are no longer reserved for retirees; the SSA also offers benefits for disability, survivors, dependents, and supplemental purposes.
How does the SSA pay for it?
You and your employer pay 6.2% (or 12.4% if you’re self-employed) of wages to Social Security, up to an annual taxable maximum ($142,800 in 2021). However, you don’t take out what you put in because current contributions fund present beneficiaries — the ultimate pay-it-forward concept.
So what happens when more people are taking than giving?
Therein lies the SSA’s Achilles heel, one administrations have been trying to repair for decades.
Can You Get What You Give? Understanding Social Security’s Shortcomings
One factor alone isn’t responsible for Social Security’s problems; a whole host of elements compounded to bring us where we are today.
- Declining birth rates. According to the Pew Research Center, the birth rate dropped 4% in 2020, and pandemic impacts alone will show 300,000 fewer births in 2021. But even before the pandemic, birth rates in the U.S were declining. 2019 marked the fifth year in a row that birth rates steadily decreased. These numbers contribute to an aging society and affect Social Security’s solvency.
- Longer life expectancy. Thanks to modern medicine, hygiene, and wellness, people live longer than ever before. It’s not uncommon for people to be retired for nearly three decades. While remarkable, longer life expectancies also strain the SSA’s reserves.
- A generational “boom.” Baby boomers, the largest generation behind millennials, are swiftly retiring — millions more in 2020 than in previous years, according to the Pew Research Center — and taking their Social Security benefits with them. This new wave of retirees could lead to more people receiving benefits than contributing to them.
- A mismatch between contributions and distributions. Census data demonstrates that while the aging population rises, the working population is falling. These trends are projected to continue, which could hinder the current pay-as-you-go system.
These factors led the SSA to announce in August 2021 that funds in the Social Security Trusts will be depleted by 2034, a year sooner than anticipated.
What happens when that day comes?
With current contributions, the SSA anticipates it will only be able to pay 78% of scheduled benefits.
Has the Pandemic Accelerated the Clock?
While the long-term consequences of the pandemic on Social Security will continue to be evaluated, there’s no doubt it has left its mark.
From early retirements to workforce contractions to coronavirus relief bills, COVID-19 has affected Social Security in the short-term.
Below is legislation that has impacted Social Security in just the past year:
- Stimulus checks — $1,200 from the CARES Act, $1,400 from the American Rescue Plan, and $600 from the Consolidated Appropriations Act — which meant those collecting Social Security (and beyond) got an extra influx of cash
- Changes to FICA payroll taxes have been reduced or delayed for certain qualifying businesses/people
- Extensive tax credits like the Child Tax Credit and Earned Income Tax Credit have broadened eligibility
And several other long-term pandemic-related concerns are being watched by the SSA, who note:
- Gross domestic product (GDP), productivity, and earnings have been permanently lowered by 1%
- Lower birth rates in 2020 and 2021
- Higher mortality rates
- Lower employment numbers
Even though the SSA feels confident this downturn won’t have a net negative impact on Social Security, sufficient funding remains an issue. What can be done?
Viable Solutions to Shore Up the System
Even though the numbers are far from comforting, Social Security trusts aren’t exhausted yet. Bankruptcy isn’t necessarily right around the corner; there are several ideas from the SSA, presidential administration, financial institutions, and more that could help repair it.
A few common considerations are:
- Amending current FICA payroll tax rules. Potential thoughts include: exceeding 12.4% of taxable wages, raising the annual taxable maximum, and raising taxes on the highest earners, among others.
- Increasing the age when you can collect benefits. The SSA has been slowly increasing the full retirement age or the eligible age to collect your total primary insurance amount (i.e. 100% of your benefits). For those born in 1960 or later, that age is 67. Check out the SSA table to see what yours is. Given longer life expectancies, this could be a natural move.
- Total benefit reduction. There are several ways this could play out. Perhaps maximum benefits for higher-earners would be limited, or retirement benefits in general could decline.
- Cost-of-living Adjustment (COLA) decreases. COLA is how Social Security benefits account for inflation. However, COLA isn’t guaranteed every year; not raising COLA could be a way for the SSA to cut costs.
- Add taxes elsewhere. For example, the SSA could tax investment income or group health insurance premiums.
There’s no way of knowing how Social Security will evolve, though some changes are likely ahead. As always, Abacus is watchful of new developments and we are prepared to help you make any necessary adjustments to your retirement savings plan.
If You Can’t Completely Count on Social Security, How Can You Mindfully Save For Retirement?
Social Security may look different in 12 years than it does today. How can you prepare for that shift?
Turn Attention to Other Tax-Advantaged Retirement Accounts
Social Security likely isn’t doomed, but it may look different by the time you’re ready to retire. While benefits may be available, they could be smaller than in years past. This means you may want to emphasize your personal investments by maximizing your tax-advantaged retirement accounts.
First, take a look at your employer-sponsored retirement account (like a 401(k), 403(b), or 457) and ask yourself:
- Do you have a company match, and are you contributing at least enough to get the total amount? Odds are, you’ll likely need to contribute well over the match to keep your retirement on track.
- Are you increasing contributions as you earn more money?
- Can you max out your contributions this year? In 2021, you can contribute $19,500. Doing so boosts your retirement fund and lowers your annual taxable income.
- Are you eligible for catch-up contributions and are you taking advantage of them? Catch-ups this year are $6,500 for those over 50, meaning you could save $26,000!
- Does your plan allow you to make after-tax contributions and should you consider it?
- Can you fund both a traditional and Roth version of your account?
- When’s the last time you checked in on your investments? Is it time to rebalance? Have your investment preferences changed (risk tolerance, time horizon, goals, etc.)?
There are numerous ways to take advantage of your employer-sponsored retirement account. It’s probably your most significant retirement investment and should have a well-defined strategy to support it.
Next, take a look at an individual retirement account (IRA). IRAs can be excellent investment vehicles for retirement. These accounts offer broad access to investments and provide more flexibility and control for a long-term investment strategy. When looking at an IRA, evaluate the following questions:
- Are you maxing out your annual contributions? In 2021, you can contribute $6,000 to an IRA.
- What about catch-up contributions? If over 50, you can put away an extra $1,000.
- Can you make deductible contributions to a traditional IRA? If you’re covered by a workplace plan and make over a certain amount of money, you can’t make deductible contributions. But that doesn’t mean contributing isn’t worthwhile.
- Are you eligible to directly contribute to a Roth IRA?
- If you exceed Roth income limits, is now a good time to consider a Roth conversion or a Mega Backdoor Roth?
- Are your allocations still aligned with your more comprehensive investment needs like risk, timeline, and goals?
Keep Funding a Brokerage Account
Brokerage accounts are one of the most flexible investment avenues out there. There aren’t restrictions on contributions or withdrawals like there are with retirement-specific accounts. You can use the funds in a brokerage account for nearly anything, and it’s a great way to save for long-term goals.
The big thing you’ll want to consider is capital gains taxes.
Depending on how long you hold an investment, the proceeds are either taxed at a favorable long-term capital gains rate or a less desirable short-term capital gains rate. If you hold your investment for at least a year, you’ll qualify for long-term capital gains, which could be 0%, 15%, or 20%, depending on your income. There has been talk about increasing the long-term capital gains rate, and it might make sense to realize more gains at these more favorable rates.
Short-term capital gains are synonymous with ordinary income tax rates. By holding your investment for less than a year, you’ll have to pay regular income tax on the sale.
- How much are you currently contributing to a brokerage account? Do you have room in your budget to increase those contributions?
- Are your allocations aligned with your broader investment strategy?
- Do you have a plan for capital gains this year (whether realizing or limiting them)?
Contribute to an HSA if You Can
A health savings account (HSA) is a valuable, tax efficient way to save for medical costs. These accounts offer three distinct tax benefits:
- Pre-tax contributions
- Tax-free growth
- Tax-free distributions for qualifying medical expenses
HSAs are truly the crème de la crème of tax-efficient saving. On top of the tax benefits, funds roll over year to year, making long-term saving a top priority. Unlike a flexible spending account (FSA), you can invest your HSA funds, opening your contributions to compound interest.
Investing your HSA funds also makes this account an incredible retirement savings tool. With healthcare costs steadily rising and Medicare uncertainties, stashing away a sufficient amount to cover your health costs in retirement is an excellent opportunity.
You must be enrolled in a high deductible health plan (HDHP) to be eligible for an HSA. HDHPs come with lower premiums and higher deductibles and out-of-pocket maximums. But the tradeoff for access to an HSA could be worth it if you don’t have frequent trips to the doctor.
Create a Comprehensive Retirement Plan that Helps You Reach Your Goals
Saving for retirement is far from straightforward.
But you can employ several strategies to help you get there; it all depends on your unique goals and dreams for your golden years.
While Social Security has long been seen as a prime way to supplement retirement income, that landscape may be shifting. Even today, the SSA estimates that benefits will replace roughly 42% of your retirement income; that number shrinks to 28% for high-income earners.
Meaning, Social Security may not take center stage for your retirement income plan, but there are many ways to make up the difference with a comprehensive savings plan and commitment to developing habits that will get you there.
At Abacus, we love helping people align their money with their values and figure out how much is needed to reach their retirement goals. Ready to take a look at your retirement plan? Schedule a call with an advisor today.