What the Social Security Squeeze Means for Retirees

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The spotlight is back on the funding gap in the U.S. Social Security system. The trigger was last week’s statement by the Social Security Administration (SSA) that 65 million Americans will not see an automatic increase in their monthly benefits because there was no increase in the consumer price index – or inflation — from the third quarter of 2014 to the third quarter of 2015. It was the third time in six years such increases were denied.

Going forward, experts at Wharton and Boston University argue that payroll taxes need to be increased to avoid kicking the can down the road for future generations to bridge the funding gap. They also note that retirees themselves could significantly increase cash flows in retirement with proper planning.

The solvency of Social Security and Medicare programs is a key long-term budget issue, says Wharton professor of business economics and public policy Olivia S. Mitchell. “If people are not taking a look at the bigger question — how are we going to support an aging population — then there will be mistakes made at the highest levels.” Mitchell is also executive director of the school’s Pension Research Council.

Another troubling issue: “About 80% of the people in the country who are hitting the retirement age are taking the benefits before [full] retirement age,” according to Boston University economics professor Laurence Kotlikoff. He is coauthor of the book Get What’s Yours: The Secrets to Maxing Out Your Social Security along with Philip Moeller and Paul Solman. He also runs the website Maximizemysocialsecurity.com.

Kotlikoff and Mitchell discussed the larger implications underlying SSA’s denial of cost of living (COLA) benefit increases on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

“About 80% of the people in the country who are hitting the retirement age are taking the benefits before [full] retirement age.” –Laurence Kotlikoff

The SSA’s announcement on COLA also covered other changes in retirement benefits. One, the statute retains the maximum amount of earnings subject to the Social Security tax, as well as the retirement earnings test exempt amounts. The current maximum annual taxable earnings are $118,500, which carries a social security tax of 7.65%. The retirement earnings test exempt amounts – how much a retiree can earn before they must start paying special income taxes — are $15,720 annually for those opting for benefits before full retirement age, and $41,880 for those who reach the full retirement age. One dollar in benefits will be withheld for every $2 in earnings for beneficiaries below retirement age, and $3 in earnings for those at full retirement age.

Medicare Premium Impact

Mitchell explained how Medicare premium increases will play out. The Medicare program has four parts. Part A covers hospitalization; Part B – which will see the big increases – covers doctor visits and outpatient hospital visits; and Parts C and D cover drugs and other benefits. Most people are protected against an increase in the Part B premium, but 16 million of the 55 million people enrolled are not, so their premiums could go up by 50%, she noted. “For example, the average person is now paying $104.90 a month, and that could go up to $159.30 a month or about $650 a year [in extra premiums]. That could be quite a shock for some people.”

However, the rules provide a safety net for many of those who may see an increase in their Medicare Part B premium, with a special provision to protect about 70% of beneficiaries from higher Part B premiums. Higher-income beneficiaries will not receive that protection.

That safety net for Medicare Part B enrollees is temporary, though, Kotlikoff pointed out. “Over time, the Social Security [Administration] will not give beneficiaries COLAs to help them catch up,” with rising costs he said. “Whatever extra premium you owe, they are going to get it out of you gradually, assuming there is some positive inflation.”

Mitchell said that while she was sympathetic to those that will see their Medicare Part B premiums rise, it is important to note that it is already heavily subsidized. Part B of Medicare is currently 73% financed by general revenue. “People aren’t paying anywhere near the full cost of the coverage that they are getting.”

Mitchell pointed to other aspects of current rules that will cause some future economic pain. In addition to the Medicare premium increase, the annual deductible will also rise next year. That increase will affect everyone…. That is an unfortunate way to help finance the system because that charges the sick – every time you need care, you have to pay more.” Eventually, however, the premium increases will become more fair — as they are applied across the board, she noted.

“I see a transition from a broad safety net, which is what we used to have, to a safety net based on low income.” –Olivia S. Mitchell

Mitchell pointed out another, “under-noticed” aspect in the current debate. Unlike earlier, Medicare premiums are now being means-tested, or income-tested, with premiums being charged based on people’s income in retirement. “I see a transition from a broad safety net, which is what we used to have, to a safety net based on low income,” she said, clarifying that she does not object to it. “It is very clear we have to means-test more of our benefits, because of the huge gap in financing,” Kotlikoff pointed out.

The Funding Gap

Kotlikoff also noted the funding projections of the Social Security program, according to the latest report of the Trustees of Social Security and Medicare. The program will be underfunded by about $25.8 trillion in present value terms over an “infinite horizon” beyond 75 years out, or 2089. “This is a terrible problem to be leaving our kids because what they are facing at the best would be a 32% increase in their payroll taxes for social security, or four cents on the dollar,” he said. “If we wait to raise this payroll tax, the increase on our kids is going to be even higher. It is a zero sum game, generationally speaking. Either we all get on board – us adults – to pay more, or our kids will face a bigger bill.”

The social security funding shortfall is part of a bigger fiscal gap of about $199 trillion the U.S. faces, said Kotlikoff. Bridging that gap would need a federal tax increase of about 53% today, including on payroll taxes, and individual and corporate income taxes. “That is how broke the country is.” Kotlikoff added that the funds crunch has come to such a pass because “we have been doing Enron accounting for decades – keeping stuff off the books.”

Leaving Too Soon?

About 80% of Americans are taking the partial Social Security benefits before full retirement age, and only 2% are delaying retirement to take advantage of incentives for higher monthly benefits at age 70, said Kotlikoff. At 70 years, the retirement benefit is 76% higher, adjusted for inflation, than at age 62, he pointed out. “You could be opening a check from [age] 70 through 100 – if you make it that long – that is 76% higher a month,” he said. “A lot of people are making a big mistake just there…. Tens or hundreds or thousands of dollars can be left on the table if you don’t get this right.”

“The benefits to delaying claiming are not only more money, but evidence shows a lot of people are healthier if they work longer.” –Olivia S. Mitchell

Mitchell added that the social security program has to be streamlined and beneficiaries have to enhance their financial literacy “so that they are better equipped to make these decisions.”

For most people, waiting until 70 would be the optimal thing to do, said Kotlikoff. “[However], some people are just desperate for cash because they’ve been laid off and can’t find another job because of age discrimination. They have no option but to take money that they can get because otherwise they are going to be starving.”

Other people could use their retirement accounts to get by or downsize their homes and keep working, he advised. “These are the people to talk to and tell them, ‘This is a major form of support for the rest of your life, and the rest of your life is going to be a very long time, and you can’t [make mistakes with] this decision.’ This is the largest retirement asset for most Americans, and it has to optimized.”

Mitchell said the Pension Research Council has published books and her own research on getting people to delay claiming social security benefits. “The benefits to delaying claiming are not only more money, but evidence shows a lot of people are healthier if they continue to work longer. They are better networked, have their community of friends and so on.”

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