As the federal election rhetoric heats up, changes to social security benefits will most certainly be a part of the dialogue. It is likely not a matter of "will changes to social security happen" but rather "what will the changes be and when".
To be clear, most all of the potential changes to social security being proposed are likely to have a profound affect on retirement benefits for millions of Americans. Therefore, it is extremely important to fully understand the effects of any of the proposed changes before you dismiss them as having little impact on your personal retirement picture.
One of the proposed changes to "fix" social security is to (once again) raise the age at which they kick in. For most American's approaching retirement now, their social security "full retirement age (FRA)" is age 66. If you were born in 1960 or later, however, the FRA is 67. But some political candidates are now proposing to push out the FRA to age 69 or even 70.
So what's the big deal about raising the retirement age anyway? Well, while raising the FRA may appear to be a small or subtle change, it will likely result in a material reduction in ones total lifetime retirement benefits. Because the monthly payments a person receives grows larger the later in life one retires, raising the FRA reduces the total amount of money paid out.
For example, if your FRA is age 66, each year that you delay the start of your benefits, your benefit payment is guaranteed to increase by 8% per year (plus any increases due to cost of living adjustments) up to age 70. That four year delay in the start of your benefits represents a 32% guaranteed increase in your benefits plus cost of living adjustments (COLA). In fact, by delaying the start of your benefits from age 62 (the earliest possible filing date) to age 70, your benefit amount will approximately double!
If the FRA is increased to say age 70, future retirees will get smaller payouts than previous ones did after starting to receive benefits at the very same age. For example, if your projected benefit at age 66 was $1,000/mo. and at age 70 it was $1,320/mo. then these benefits under an FRA of age 70 would be only $760/mo. at age 66 and $1,000/mo. at age 70. This effective reduction in benefits could significantly effect ones retirement income on both an annual basis as well as on a cumulative lifetime benefits basis. In addition, it's important to note that the effect of all future COLA's would also be reduced since the COLA's will be applied to lower benefit amounts.
Would changing the FRA be the best approach to tackling the financial challenges affecting social security? What if the FRA was only increased to age 68 instead of age 69 or 70? What effect would that have in closing the budget gap? Apparently, increasing the FRA from age 67 to age 68 would only erase 12% of the deficit that social security is expected to face 75 years from now. Nevertheless, this type of change would still have a significant affect on the financial circumstances of lower and middle income earners in retirement.
What if instead changes were made to the way social security taxes work? Currently, social security taxes are only applied to earnings up to $118,500. This is in contrast to Medicare taxes which apply to all earnings. What if social security taxes were also applied to all earned income as well? If that were to happen it is projected that it would reduce the expected deficit 75 years from now by 70%! This approach would also spare the lower and middle income earners from sharp reductions to their retirement benefits.
Clearly, there are numerous alternatives available to addressing the financial challenges facing social security. The "best" approach will undoubtedly be hotly debated. Perhaps it will require a combination of changes in order to reach a political compromise. As the banter surrounding changes to social security benefits increases be sure to ask and get answers to exactly how these changes would affect your own benefits as these changes could have a significant affect on your retirement income for perhaps decades to come.
Ash Ahluwalia, NSSA, CCSCA, MBA