EP 159: The Sustainability Of Social Security And What It Means For You

by Peter Lazaroff | Jul 3, 2024 | Podcast

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This week we are going to talk about Social Security in a way that builds on our previous two episodes. In Episode 157: Why the US Dollar Rules the World, we discussed what it means to be a reserve currency, why the US dollar holds its dominant reserve currency position, and the likelihood of the US dollar losing that status.

In Episode 158: Will the US National Debt Cause Problems Soon?, we built on some of those ideas and also introduced important concepts from Modern Monetary Theory (MMT) to better understand $34.6 trillion of national debt and how deficits really work.

There are few topics as broadly misunderstood as US government spending and, as a result, many of the conversations around Social Security from a policy perspective are off the mark. I also think many people lack the appropriate context for Social Security in their financial plan and personal investment portfolio.

So that’s the goal of this episode: to help you better understand how to think about Social Security within your financial plans and personal portfolios. But to do so, we first must understand the financial wellbeing of Social Security as well as potential policy changes that could impact the program in the future.

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The History of Social Security

President Franklin D. Roosevelt signed the Social Security Act in 1935 as part of a system he believed could provide financial security for everyone in this country “from the cradle to the grave,” as he put it.

Because this was a massive financial proposal, FDR wanted to reinforce the idea that Social Security was self-sustaining and so the Social Security Act of 1935 tied the payment of benefits to a payroll tax. We are all familiar with the FICA line item on our paychecks—which stands for Federal Insurance Contributions Act—and most people think of Social Security benefits being funded purely from the revenue that payroll tax generates.

In the Social Security Act Amendments of 1939, FDR established a trust fund that invested revenue from the FICA tax that wasn’t needed to pay out benefits in any given year into US Treasuries.

The other notable component of the 1939 legislation was the establishment of a board of trustees tasked with projecting out Social Security’s fiscal solvency 75 years into the future.

It’s hard enough to predict what will happen one year from now or ten years from now, so naturally we should be skeptical of 75-year projections of a wide range of variables such as population growth, the number of people working, changes in wages, economic growth and inflation, etc…That’s a lot to predict.

All that said, projections today say that current reserves within the trust fund for Social Security are projected to run out by 2035.

Herein lies the mistake FDR made. He hoped people seeing the money available to pay benefits would make the Social Security program more politically viable. However, everyone can “see” today that the money isn’t there.

Once the trust fund accounts are empty, benefit cuts will be triggered, but not because the government can’t afford the payments. No, it’s because Congress wrote a law that says it will not pay full benefits if the balances of the trust funds ever fall below zero.

We do not lack the financial ability to pay, but the legal authority to pay.

This is where listening to the prior episode on the US national debt could be helpful. As we have already established, the United States government can always pay its bills because they can simply print as much money as it needs. Deficits and the national debt don’t really matter because the risk of default is effectively zero. The real risk of too much money printing is inflation, but more on that when we get to talking about financial planning and personal investing implications.

Congress could fix Social Security’s “solvency” problem by simply rewriting the law. Why haven’t they done so? To date, most politicians seem to think that the best way to preserve the program is to shore up the trusts funds so that 75-year projections can show it as fiscally sustainable.

But they could simply write the law the way Medicare law is written. Within Medicare, there are two trusts: Supplementary Medical Insurance (SMI) and Hospital Insurance (HI). While the Hospital Insurance faces long-term financing shortfalls, projections for Supplementary Medical Insurance (Medicare Parts B and D) remain healthy because it has the legal authority to pay full benefits if the trust funds are ever exhausted.

It’s really that simple. Social Security should only be considered to be at risk of insolvency because the government isn’t yet committed to making payments. Because all we ever hear is that “Social Security is going broke,” most people don’t realize that the choice to fix the problem is a political one and not an economic one.

Potential Changes to Social Security

Even though rewriting the laws governing Social Security financing and payments would completely erase the issue of solvency, I think it’s more likely that legislation is passed to reduce benefits and that has real implications for your financial plan.

I’m going to share a few of the most commonly discussed ideas, but I really have no sense for the probability or timing of any coming to fruition. As you hear me think out loud about these ideas, please trust that I’m doing so without any political agenda. Instead, picture us sitting together in a client meeting and I frame up how possible changes could impact your financial plan.

The proposal that seems to get the most airtime—at least from my perspective—is means testing Social Security, which would reduce or eliminate benefits for people with higher income or net worths.

I’ve always thought this seems somewhat sensible, but I do wonder if such changes would undermine long-term support for the program because people might then begin viewing Social Security as a welfare program rather than the universal entitlement program it is today—and there is a huge difference between welfare and entitlement, but I’ll set that tangent to the side for now.

However, I can see politicians liking all the nuances and measurements involved with means-testing that could be debated and negotiated. We’ve got to give the politicians something to argue about, right?

Changing the full retirement age for collecting full Social Security benefits is another commonly discussed idea that seems a lot simpler than means-testing. Not only does this reduce the amount of benefits a retiree receives, but it also theoretically could increase the number of years someone works and continues paying FICA taxes.

You could also point to the fact that people are living much longer than once before; however, there is also pretty concrete data showing that life expectancy is closely tied to income. I’m not saying that makes increasing the full retirement right or wrong, but it’s worth noting as we handicap different possibilities.

Increasing taxes is always an option that is discussed. In 2024, earnings above $168,600 are exempt from Social Security’s 6.2% payroll tax. Increasing that threshold would provide a relatively hassle free way to increase tax revenues earmarked for Social Security benefits. It’s hard to picture this type of thing happening anytime Republicans control Congress, but this is a change I’d expect to see at some point over longer time horizons.

Creating stricter disability benefits criteria gets less airtime than these other policy changes. I feel like the criteria is already pretty strict, so I’m not entirely sure what the tradeoff between stringency and savings would be. But I don’t let this idea distract me too much with clients because I prefer they rely on private disability policies in their work years while being self-insured for disability in retirement.

How to Incorporate Social Security into Your Financial Plan

With everything we’ve discussed today, it’s time to address the big question: How should you incorporate Social Security into your financial plan? And what about your portfolio?

Different parts of financial planning require different assumptions about Social Security.

A place you should always include Social Security is in tax projections, particularly as it pertains to decisions around Roth conversions and large charitable donations. Excluding Social Security income in any evaluation of the tradeoffs between paying taxes today versus in the future would be very aggressive.

When performing Monte Carlo simulations to test how changing market conditions or other variables would affect your ability to meet your goals, I think it’s best to exclude receiving Social Security. If you aren’t familiar with a Monte Carlo analysis, it’s when you run assumptions about all of your future inflows and outflows through a series of randomized return streams that uses another set of assumptions regarding the returns, volatility, and correlation of different investments.

Yes, you heard me correctly, that’s two entirely different sets of assumptions mentioned in a single sentence describing a Monte Carlo simulation. The Monte Carlo isn’t supposed to be crystal ball, but rather it acts as a framework for making decisions about things in life such as your asset allocation, when to retire, and how much you can afford to spend.

By assuming you’ll receive no Social Security payments in your base case scenario, you create a more conservative framework from which to make decisions. Even though I feel fairly confident that everyone will receive some form of Social Security payments, I feel strongly this is the best way to run a base case. The great thing about Monte Carlos, though, is that you can run lots of iterations off that base case.

For example, let’s say you are in your 50s and thinking about retiring before age 60, but your base case doesn’t give you enough confidence to pull the trigger on an early retirement. Adding back in Social Security might give you the necessary confidence, and I think it’s very reasonable for people in their 50s to expect some form of Social Security payments.

The underlying assumptions of a Monte Carlo, including whether or not you will receive Social Security, will likely have some impact on your asset allocation, but I wouldn’t think it would be material.

As for your portfolio, I don’t think there is a material one-to-one impact from the current solvency of the Social Security trust accounts or potential changes to the Social Security program.

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