Plan on Less Social Security and More Tax
(Written for a NAPFA press release)
By Henry K. (Bud) Hebeler
As a participant in the Social Security Administrationís conference on the Future of Social Security, I was shocked, even though I was prepared to hear bad news. The size of the problem is monstrous. The present value of projected future Social Security cash outflows less Social Security tax receipts for Social Security is over $10 trillion, or about 1.5 times the national debt. In other words, itís equivalent to about $100,000 debt per family right now just to pay for the difference between the promised benefits and the actual tax collections, never mind the amount of money to actually pay the benefits.
There were two basic approaches proposed to solve the problem. Prof. Peter Diamond of MIT showed a "Nip and Tuck" solution where there would be adjustments to virtually every aspect of both the benefits and taxes. Dr. Martin Feldstein of Harvard preferred the government initiate personal accounts which would emphasize the potential growth of the benefits by allowing people to invest half of their tax deduction in their own choice of mutual funds as now done in Sweden.
The Nip and Tuck method would require several tax actions including increasing the payroll tax from 12.4% to 18.5%. On the benefits side, the minimum retirement age would go from 62 to 65 and the full retirement age to 70 from its current value that ranges from 65 to 67. Prof. Diamond also suggested a revision in the Social Security inflation adjustment.
Dr. Feldsteinís personal account solution will only work if participants choose a high stock allocation, fees are low, and the future stock market performance is similar to the long-term past. He suggested that mutual funds could offer some minimum guarantees if they used either stripped TIPS or a combination of puts and calls. This would require relying on the derivatives markets. Even then, the individual accounts method would require some of the Nip and Tuck adjustments. In a Wall Street Journal column, Dr. Feldstein said that very high income people might lose 80% of their benefits. (WSJ, 8/17/04)
So, whatís a person supposed to do about projecting Social Security? It depends on when they expect to start taking the benefits. It is likely to take years before Congress will be willing to change the retirement ages and increase payroll taxes for Social Security. So those near retirement now may be hurt less. However, those who are in their early fifties or younger should plan on taking benefits later, discount the value of their benefits, and plan on higher taxes on their Social Security income.
Obviously, these people will need more savings to preserve a comparable lifestyle. Probably the least amount of additional savings would be for those with low incomes and taxes. That might be additional savings equal to three years of Social Security payments including all inflation adjustments until retirement. Higher income people will have to cope with higher taxes as well. Right now, higher income people take home less than two out of every three Social Security checks. The third check goes back to the government in the form of taxes on their Social Security. All income groups are likely to have less than perfect inflation adjustments.
People not yet on Social Security often fail to realize that they also will have a Medicare Part B deduction, now $66.60 per month. This has been increasing significantly faster than inflation, and itís hard to believe that it wonít continue increasing at discouraging rates. Those who have to provide their own health insurance until Medicare starts must plan on hefty outlays that have been increasing even faster. The current age 65 for Medicare may well have to increase as well because Medicare is even sicker (pun intended) than Social Security. Nor is there a brighter outlook for long-term-care insurance. Selecting a retirement age requires a very detailed financial look including lower benefits and a broad and well considered view of acceptable risk.
Reducing projected benefits and increasing related taxes will require a heavy hand, not a light touch. This problem is huge and unavoidable. Unfortunately, itís exacerbated by record levels of all kinds of debt: international trade balance, national debt, state debt, and personal debt. The classic solutions to government debt are to reduce government spending (unlikely) and to increase taxes and print money. The latter, of course, leads to significant inflation which makes the debt seem relatively smaller. Retired people who have a pension from an employer in financial trouble have another kind of problem. The Pension Benefit Guarantee Corporation, PBGC, is in very bad shape and needs a huge bailout from the Congress. Even with Congressional funding, most people will get significantly less than their current projections if they have to rely on checks from the PBGC which has both a limit to the maximum it will pay and severely discounts the payments of those who are not yet retired.
There has never been a time when itís been more important for people to look ahead, increase savings, and invest wisely.
Henry K. (Bud) Hebeler is a retired president of The Boeing Aerospace Co., the division responsible for Boeingís space programs and most military products. He was an economics consultant to Washington Stateís governor and to the Federal governmentís Secretaries of Interior, Energy, Commerce, and Defense. He is the author of J. K. Lasserís Your Winning Retirement Plan and is often quoted in the national press. Many of his articles are on www.analyzenow.com.