Investor's Business Daily: Should You Pull Money Out of Social Security
Deciding when to claim Social Security benefits should be a simple math exercise focused on longevity, taxes and income needs. But another existential risk looms.
Uncertainty about the solvency of the trust fund that pays Social Security benefits is adding a new twist to the claiming decision. Social Security's financial woes could result in the trust fund being depleted by late 2032. That would lead to a 22% benefit cut if Congress doesn't shore up the retirement benefits program, according to government projections.
The thought of getting only 78% of scheduled Social Security benefits if the trust fund runs out of money is weighing on retirees and future retirees. The reduced payout will be funded by ongoing Social Security payroll deductions by U.S. workers still paying into the system.
Social Security Woes Mount
Headlines about Social Security's financial troubles have panicked Americans nearing retirement. They wonder if they should take benefits early at age 62, financial advisors say. The thinking? Get my money before the trust fund goes dry.
Research from Cornell SC Johnson College of Business reveals that most Americans "misinterpret what happens" when the Social Security trust fund reaches zero. "When people see charts or headlines focused on the shrinking trust fund balance, nearly two-thirds believe benefits will stop entirely after depletion," said professor Suzanne Shu.
That's completely wrong. Social Security is not going away. "Trust fund depletion does not mean Social Security disappears," said Bradford Houchins, wealth advisor at River Wealth Advisors.
What Actually Happens When Social Security Runs Dry
Americans still working will continue to have Social Security taxes deducted from their paycheck each pay period. And those deposits will fund an estimated 78% of scheduled benefits for Social Security beneficiaries starting in late 2032 — even if Congress doesn't come up with a financial fix.
Financial advisors say making such a huge financial decision based on fear and speculation about what U.S. lawmakers will or will not do is a major mistake.
Claiming early out of fear of benefits going away entirely (which they are not) may leave retirees in a worse financial position, says Houchins.
Claiming Social Security at age 62, the earliest claiming age, results in a 30% smaller benefit check than one would receive at 67, or full retirement age (FRA), or if you delay benefits up to age 70. "If you take Social Security early, you guarantee yourself a 30% lifetime benefit reduction," said Houchins.
And for married couples, filing early will result in smaller benefits for a surviving spouse. The math gets even worse if you combine a smaller monthly benefit check due to claiming early and lop off another 22% if there's a benefit cut in 2032. "A future 22% benefit percentage cut would also be applied to the permanently smaller monthly benefit created by claiming early," said Houchins.
Keep Politics Out Of It
Political anxiety about Social Security's ability to pay in the future should not dictate claiming decisions.
Ash Ahluwalia, a certified financial planner who specializes in Social Security at Prosperity Capital Advisors, says making a huge financial decision based on something that might not even happen is not prudent.
He doesn't expect benefit cuts to occur. The political cost for lawmakers is too high given that roughly 70 million Americans receive Social Security. "I don't see it happening," said Ahluwalia.
Congress has many options on the table to stabilize Social Security's finances, adds Ahluwalia.
Options For Social Security
Lawmakers could raise revenue by increasing the Social Security payroll tax. Currently, employees and employers both contribute 6.2% of salary. They could also increase the amount of wages that are subject to taxes. Currently earnings only up to $184,500 of pay are taxed by Social Security. Other possible fixes include eliminating annual cost of living increases and raising the retirement age. Currently, full retirement age (FRA) is 67 for Americans born in 1960 or later.
"Workers and retirees should be looking at their specific consequences if a government cut occurs," said Houchins. "We want to base those judgments on facts."
That means calculating how much a 22% benefit cut would impact a financial plan and retirement income needs over time.
Run A Social Security Stress Test
Financial advisors say you should do a stress test on the various Social Security outcomes based on different claiming ages. In short, run the numbers to shed light on the pros and cons of claiming early versus waiting to take benefits later.
The goal: incorporate a potential 22% reduction in Social Security benefits into a financial plan and measure the impact.
"Compare taking Social Security at age 62, age 67, which is full retirement age with no benefit reduction, and at age 70 (when you receive an 8% benefit increase for each year from FRA up to age 70)," said Houchins.
Run The Numbers
Tally up your full monthly benefit at each claiming age. Next, factor in a potential 22% benefit cut. And then back out the lost retirement income.
"Work the model out," said Houchins. "See where the numbers come out in the end (under all scenarios)."
Ahluwalia says workers should think long and hard before taking benefits early and locking in lower benefits for life.
The reason: With fewer workers receiving traditional pensions, Social Security serves as many retirees' sole pension-like income stream.
"For many, it's the only retirement income stream they can't outlive," said Ahluwalia. "To put a deep cut in it (by claiming early) could really hurt later in life."
Adjust Financial Plan If Needed
If an income gap is caused by potential benefit cuts, adjust your financial plan to cover or close any shortages.
"It all comes down to preparation," said Houchins. "Look at what your plan is, what your income needs are, and plan for the worst-case scenario. Look at any potential income shortfalls and see how it's going to impact the long-term financial plan."
There are many strategies to employ to make up for lost income.
For married couples, it could make sense, for example, for the lower-earning spouse to take benefits early and have the higher-earning spouse wait until FRA or age 70 to lock in the biggest spousal and survivor benefit.
If savings balances in retirement accounts allow for it, retirees can pull from 401(k)s and IRAs first to meet monthly expenses and delay taking Social Security as long as possible to reap a larger lifetime monthly benefit.
Boosting annual savings in the years leading up to retirement can also help fill any income shortfall that results from cuts in Social Security benefits.
Handle Emotions About Social Security
Workers nearing retirement should not let emotions take hold. Fear is not a reason to take Social Security early due to worries about the government's ability to pay.
"Nothing good happens when you panic," said Houchins.
Instead, let a thorough analysis of the pros and cons of claiming Social Security at different ages make the decision. You might also work a year or two longer or trim the family budget if you think Social Security benefits will be cut, adds Ahluwalia.
Ultimately, what retirees are trying to accomplish is this: create a retirement income plan that delivers a longer guaranteed, predictable form of income moving forward.
"When we have better facts on the ground, we're going to be able to make better decisions," said Houchins. "This isn't just a numbers game, it's an emotional game, too."
Disclosure: The scope of any financial planning and consulting services to be provided depends upon the terms of the engagement, and the specific request and needs of the client. River Wealth Advisors LLC (“River Wealth”) does not serve as an attorney, accountant, or insurance agent. River Wealth does not prepare estate planning documents or tax returns, nor does it sell insurance products. Click here to review our social media disclosures.