As financial advisors help clients prepare for retirement, one of the important sources of income, is seriously misunderstood — Social Security. According to a survey conducted by AARP, (reported in August 2015
) the Social Security benefit, overall, represents roughly 38% of the income of senior citizens. For many, the benefit represents over half of their retirement income.
Helping Clients Project Benefits
When assisting young clients it is clear that many of them do not believe they will have a Social Security benefit at all — this, despite a report from the Social Security Trust Fund that, unless changes are made, the fund will be depleted in by 2034. However, even then, the trust fund report tells us that about 79% of benefits will continue to be paid from current payroll taxes being contributed and taxes on those benefits.
If changes are made by Congress, the Social Security Trust Fund will be solvent well beyond 2034 (some estimates suggest to 2089). For example, if the cap on earnings is removed ($118,500 in 2015) and the current payroll tax of 6.2% is raised to 7.2% over a period of 20 years the funding gap would be closed, and an extra margin of safety would be added.
The changes would also include an increase in the minimum Social Security benefit, and a slight adjustment to the cost-of-living (COL) increases to better reflect the COL for seniors. The AARP survey tells us that 7 in 10 prefer this package of changes to ensure that Social Security benefits will continue intact for their children and grandchildren.
The problem? Reforms to Social Security may be a long time coming. The last major reforms (including increasing the retirement age) took place in 1983 after a year of negotiations by a non-partisan commission led by Alan Greenspan. Those changes were phased in over a 22-year period.
In the meantime, when financial advisors are helping clients identify the sources of retirement income, how does Social Security fit into the mix? The younger the client, the more difficult it will be to offer a reasonable projection of that benefit. Perhaps the answer lies in projecting the other sources of income — firmly encouraging voluntary savings for retirement, and considering Social Security to be only an extra retirement cushion.
Reduced Social Security Benefits for Some
Additionally, the survey estimates that some 40% of teachers do not participate in Social Security at all, and those individuals will need to bolster voluntary savings for a comfortable retirement. Even teachers who believe that Social Security coverage from a different job will pay a specific benefit will be surprised to learn that the benefit will be offset substantially under the Windfall Elimination Provision put in place during the Reagan administration.
The theory is that individuals who worked at previous jobs where there were not substantial earnings, or less than thirty years of paying into Social Security would receive the minimum Social Security benefit which was designed to replace about 60% of pre-retirement earnings. This contrasts with higher income workers whose Social Security benefits are designed to replace only about 25% of pre-retirement earnings. A calculation of the amount of reduction in Social Security benefits can be done using IRS Publication 05-10045. There is a second potential reduction in Social Security benefits which affects the individuals receiving a benefit as a spouse or widow(er). Called the “government pension offset,” the calculation for the reduced Social Security benefit can be found in IRS Publication 05-1007
Because some pension benefits are being reduced, and, because the amount in Social Security benefits cannot be accurately calculated for many clients, the one remaining leg of the three-legged retirement income stool is personal savings. Financial advisors are uniquely positioned to help those clients both participate in retirement savings plans, and increase contributions to those plans over the years. The role of the financial advisor has grown in importance over the years, and they now are essential to the comfortable retirement of millions.