By Joe Elsasser, CFP
Each year we wait on pins and needles for the Social Security Trustees report to be released. The report explains the current financial status of the Social Security system and outlines potential future paths for the program. Often, it recommends changes and includes an estimate of how much change would be necessary to put the system on stable long-term footing.
This year’s Social Security Trustees report was not as scary as many might have expected, with the estimate for depletion of the trust funds moved up just one year, from 2035 to 2034 for the combined Old Age Survivors and Disability (OASDI) trust funds and from 2034 to 2033 for the OASI fund (excluding disability). However, there are a few reasons you should stress test your retirement strategy to prepare for more dramatic changes.
The Trustee’s report is required by law to be presented to Congress by April 1st. It is frequently issued after the deadline, but this year’s report, issued on August 31st was the latest in history. The delay could have something to do with internal turmoil at the Social Security Administration. While we don’t know the precise reason for the delay, the disorder within the Social Security program is something to note when preparing for the uncertain future of the Social Security program.
Changes to Assumptions
The 2021 Social Security Trustees report includes some big changes to the assumptions. The report anticipates significant increases in labor-force participation and fertility. An increase in both categories would have a positive impact on the long-term solvency of the system. If more people are working or actively seeking work, assuming the same general increase in average wages, then the tax revenue coming into Social Security is higher. If the average woman has two children instead of 1.8, we see a similar effect – a greater labor force supporting Social Security’s retirement benefit payments.
However, the reasoning behind the change is unclear. According to Jason Fichtner, PhD, a former Deputy Commissioner of Social Security and now the Chief Economist for the Bipartisan Policy Center, “it's a peculiar change to make this year, because these assumptions were specifically and deliberately changed just one year ago, and because fertility rates even before the pandemic were lower than what the Trustees are assuming now.”
A second set of assumptions that are troubling and likely to have a near-term impact on the solvency date that is published in next year’s report, are the assumptions for inflation and average wage growth. Inflation is significant in the near-term because higher-than-projected inflation results in higher cost of living adjustments for all current beneficiaries, immediately increasing program costs. The report projected inflation at 3.06%, but current estimates for 2021 inflation are coming in near 6 percent. It then assumes a 2.4% inflation figure thereafter. If inflation remains higher than projected, the trust fund depletion date could be further negatively impacted.
Average wage growth impacts the revenue used to fund the Social Security program and impacts the initial benefit amounts. If wages are growing, so are program revenues, and so are initial benefit amounts. The Trustees report assumes 2.73% wage growth for 2020 and 6.22% for 2021, which is dramatically higher than recent averages. These assumptions, particularly the assumption for the 2020 average wage index, is considerably out of line with expectations.
As recently as November 24, 2020, the office of the chief actuary for Social Security suggested a 4.01% decrease in the average wage index primarily due to the widespread unemployment during the pandemic. A decline in the average wage index would cause significantly lower benefits for newly eligible Social Security beneficiaries, reducing program costs, but would also reduce the income coming into the program. Although later research suggests that the reduction in the average wage may not be as significant as originally feared, few expect wage growth to be positive.
“The pandemic and precipitous recession have clearly had significant effects on the actuarial status of the OASI and DI Trust Funds, and the future course of the pandemic is still uncertain. The Trustees will continue to monitor developments and modify the projections in later reports.”
This disclosure accompanies the report. It’s not unusual for a similar disclosure to appear in a Trustees report. After significant policy changes or economic events, such disclosures are relatively common. The disclosure is a key indicator that we don’t know the full effect of the pandemic on Social Security, and it might be a while until we know the full scope.
According to Olivia Mitchell, PhD, Executive Director at the Pension Research Council and Professor of Economics at Wharton, “One of the biggest sources of worsening in the Trustee’s report is the simple passage of time: moving the valuation period forward one year worsens the actuarial balance by 2.21%. And every year into the future, this will continue to become a bigger and bigger problem.”
Preparing for an Uncertain Future
Ultimately, some combination of changes will be necessary, and we should expect that as the trust fund exhaustion date approaches, calls for reform will increase. Reforms are unlikely to impact every individual equally. As you evaluate your retirement income plans, be sure to consider how changes or cuts might impact your plan specifically and consider contingency plans. Don’t make poor a Social Security claiming decision based out of fear. Testing your retirement strategy to make sure you’ll still be able to reach your goals even if the cuts to Social Security are more dramatic than the latest Trustees report suggests is key. Talk to your financial advisor about how benefit cuts would impact your situation.
About the author: Joe Elsasser, CFP®
Joe Elsasser, CFP® is the founder and president of Covisum®, a financial tech company focused on creating software solutions, practice management and marketing resources to help advisers and financial institutions grow and improve lives through better retirement decisions. Covisum helps financial advisers serving mass-affluent clients in or near retirement and powers some of the nation’s largest financial planning institutions.
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