Millennials are worried that Social Security won’t be there for them at retirement, and they have good reason. For them the promise of retirement is looking increasingly weak.
Retirement in 20th Century America was built on what financial advisors call the three legged stool: 401(k)s and other retirement accounts, pension funds and Social Security. Together these ensured that most retirees could live comfortably despite their years out of the work force. The trouble is, as longevity has increased, many of these systems have been put to the test.
It’s the subject of a forum hosted today by the Museum of American Finance and Bank of America, and an issue that should concern Millennials the most.
First, companies began eliminating pensions, dropping them in favor of matching retirement contributions or nothing at all. Then personal finances began to strain Americans’ abilities to make meaningful contributions to their own retirement funds. Most recently, Social Security has increasingly come under attack as an unaffordable luxury.
The strain of supporting a population that will only work for about half of its life is beginning to show, and for Millennials, the danger is distant but acute.
In fact, it’s already begun.
As Bob Kerrey, former Democratic Governor and Senator of Nebraska, explained, Congress has already acted, cutting Social Security benefits by 25% for everyone currently under 40. This isn’t the only new change to the New Deal program either, as Congress has also acted to restrict flexibility by limiting popular options such as file and suspend and restricted applications (both relatively technical rules, deserving of an explanation in more space than is available).
It’s a move that would be politically unthinkable for current or imminent beneficiaries, but with Millennials and younger Gen X-ers, it’s a safe bet. Safe enough, in fact, that many members of this cohort don’t even know what’s happened.
“It’s a transfer program,” Kerrey said, calling the benefits reduction Social Security’s “dirty little secret.”
“That isn’t fair,” he added. “If there’s any crisis at all, it’s a crisis that we’re not having an honest conversation about where does the money come from to pay for the current retirement benefits, particularly for Social Security and Medicare benefits.”
Politically, the question of how entitlements work has been toxic enough to earn its status as the third rail in American politics, because the system is built around a polite fiction. We call them “entitlements,” because Social Security and Medicare are built around the idea that they operate as a sort of government-mandated retirement program. Seniors feel owed their benefits on the basis that they’re collecting back on a program they’ve paid into for their entire working lives.
“Every single person who’s currently running for president, all six of them, are pandering to seniors,” Kerrey said. “Every single one of them are saying to seniors, ‘you’re just getting what you’re entitled to.’”
The well documented reality, however, is that these days seniors withdraw an average of $7 for every one that they’ve paid into the system.
The result has put financial strain on the guaranteed entitlement system that Social Security operates on, while at the same time making it virtually impossible to cut benefits for near-retirees who feel that they’ve earned their money. Millennials, as voters with retirement a long way off, are less likely to revolt.
And they haven't.
“The unpleasant reality for the Millennials is not college debt,” Kerrey said. “It’s the imbalance in benefits to Social Security under current law.”
“[It] is a very good program, and it wouldn’t take much to fix it," he added. "The problem is it’s going to take a lot because politicians aren’t going to address it. Seniors are going to go bananas and they won’t vote [for anyone who acts], and 80% of seniors vote.”
As a result, Millennials need to start planning for this leg of the tripod to get pretty wobbly.
Part of the trouble with planning for a retirement without Social Security is that it removes the last constant. Retirement planning is a game of shifting variables. How much money can you squirrel away? What will be your employer contributions over a career? How long will you live? When can you pay off student loans? When will you have to stop working?
All of these questions are largely unanswerable, but at least Social Security has given Americans a baseline of reliability.
According to David Leland, a wealth advisor with Merrill Lynch who specializes in this Social Security planning, that doesn’t mean that 25-year-olds need to put away their dreams of retirement. Instead, they just have to realize that what was a guarantee to their parents has become a variable for them.
“I think it’s a big deal from a fairness standpoint,” Leland said. At the same time, he pointed out, Social Security’s weaknesses can be planned around.
“I think the Millennials look at it and say, ‘Fine, in fact I’ll agree right now, don’t give me any Social Security benefits. Just stop making me contribute in,’” Leland said.
The first step, he suggested, should be for any young worker who can do so to create and maximize a Roth IRA. For most Millennials, it’s a safe assumption that they’ll be earning considerably more by the time they hit retirement, kicking them into a much higher tax bracket than the one they enjoyed in their 20s. Since a Roth IRA limits the tax contributions to what was paid on the money going in, it allows Millennial planners to lock in their current lower tax rates on those investments.
It’s a powerful enough tool that many Baby Boomer parents Leland works with have begun to incorporate it into their estate planning.
“Part of the gifting strategies that our older, wealthier clients are considering is funding their [children’s] Roth IRAs for them,” Leland said. “From an estate planning standpoint, some of these clients are intentionally funding Roths for themselves, doing conversions, knowing that they’ll probably never spend that money. What they’re looking at is they’re making it part of their estate.”
It isn’t pure generosity, he pointed out. The parents who create these savings accounts for their children do so, because they don’t think Social Security will still be there in 40 years.
For young workers who don’t come from relative wealth, Leland said that the solution is to begin saving now, whatever it takes. The power of a retirement account comes from compound interest slowly adding up over decades of stable investment.
Mutual funds, he suggested, would be the best option for the average retirement investor.
“This isn’t the first time that there’s been a major change to the way people retire,” he said. “There’s nothing that the younger person can do other than plan around it.”
“Fortunately,” Leland added, “I think the Millennials are aware of where they stand and they’re aware early enough that they’re not going to be blindsided.”