Not all Americans expect to count on Social Security in their old age — and this confusion could cost them.
The trust funds that support Social Security are on track to run out of money in the next 15 years, at which point, if nothing is done, the government is expected to pay beneficiaries only about 80% of their benefits. Congress has never let the program falter, but it has also not yet made a decision on what to do about this insolvency issue. That can pose a problem for Americans looking to plan their retirement income needs.
The value of knowing today what the government will do in 2035, should the trust funds be exhausted by then, might be worth as much as two and a half months of earnings, according to a paper the National Bureau of Economic Research recently distributed.
Here’s how the researchers broke it down: if a woman born in 1975 with average earnings plans to retire with no anticipation of benefit cuts, but then finds herself with a 20% benefit cut in 2035, the “value of becoming aware of the policy 15 years in advance” is about $9,000 in 2020 dollars, or 1.5 times her average monthly earnings.
This calculation is based on her ability to make more informed decisions for her finances, the researchers said. If she were to be surprised by a policy change in 2035, her consumption would decrease to reflect the lower benefits she receives. If she were to know ahead of time, such as in 2020 that benefits would be cut 20% in 2035, she would be able to make an immediate adjustment to her consumption.
“The ability to make an immediate adjustment hinges on whether the individual has already started saving for retirement — in which case saving can be adjusted in response to the announcement,” they said. “This decrease in consumptions is subsequently followed by an increase in savings to offset impending benefit cuts.”
Relative to earnings, this information is more valuable for low-income workers than high-income workers, because those are the individuals who rely on Social Security more heavily.
“These gains represent a ‘free lunch’ in the sense that they can be realized just by making a decision about a problem that will have to be faced in the near future,” the researchers wrote. “Failing to do so complicates people’s retirement plans. Thus, government indecision has a real cost.” The paper was written by John Shoven, research associate at Stanford University; Sita Slavov, faculty research fellow at George Mason University; and John Watson, also from Stanford University.
In an updated Social Security analysis in November 2020, Stephen Goss, chief actuary at the Social Security Administration, said the anticipated depletion could be as early as 2034.
The effects of the pandemic on Social Security are still unknown as well. The COVID-19 crisis has impacted Americans’ employment, savings and health, as well as death and fertility rates.
Many retirees rely on Social Security for at least a portion, if not more, of their income in retirement, and knowing whether or not to include these expected benefits could alter how much more or less a person needs to save for their old age. For example, if an individual expects he will not receive any Social Security benefits later in life, he’ll have to save more in his retirement accounts to make up the difference. Some financial advisers tell their younger clients to assume a reduction in benefits, just so that they don’t end up with a shortfall at an older age.
Another mistake, researchers said, is in assuming benefits will be cut or nonexistent — though at least they’d then have more money stashed away for retirement.
“These costly mistakes would be avoided if the government made a decision today about what it will do when the trust fund is exhausted,” the researchers wrote. “The failure to realize the awareness gains that we calculate represent the cost of Washington failing to come to grips with the Social Security solvency issue.”