Will Fixing Social Security Hurt Your Retirement?

The Old-Age and Survivors insurance (OASI) and the Disability Insurance (DI) together make up what is known as the Social Security Trust Funds.  Our Social Security retirement benefits are paid from the OASI Trust Fund, while benefits to disabled workers are paid from the DI Trust Fund.

If the Social Security disability trust fund runs out of money in late 2016, the 11 million people receiving DI benefits could face a big reduction in their monthly benefits. And if Congress makes a move to subsidize the disability fund with money from the retirement fund, it could have a long term negative impact on the Social Security program.

Matthew Sadowsky, director of Retirement and Annuities at TD Ameritrade, discussed with me ways for baby boomers to safeguard their finances and retirement savings from any potential disruptions in Social Security benefits. Here is his advice:

Boomer: Are Social Security disability funds at risk of disappearing as early as 2016?

Sadowsky: Not of disappearing in 2016, but certainly there is a threat that they could be reduced. Barring any action by Congress, the Social Security disability fund is expected to run dry in 2016, so benefits would only be funded from the current tax revenue coming in from employee payroll taxes. For Americans who receive disability benefits, this would probably trigger an automatic 19 percent cut in benefits (the average monthly benefit is $1,017, bringing it down to $824 a month).

Rather than that happening, though, many people expect Congress to take action and shift funds from Social Security’s retirement fund to the disability trust fund, like they have done in the past.

Boomer: What effect would this have on the Social Security retirement benefit fund?

Sadowsky: The retirement benefit fund is already in a precarious situation. The trustees that oversee Social Security project that the fund could be depleted by around 2035, and at that point, payroll taxes are only projected to support roughly 75% of retiree benefits. Using the retirement fund to subsidize the disability fund would obviously put a further drag on the retirement fund. But the good news is that the trustees believe that if the two funds were combined, the impact would only be to shorten the life of the retirement fund by about a year.

Boomer: With an estimated 10,000 baby boomers reaching the retirement age every day, should we be worried about the viability of the Social Security program? How could Congress fix the shortfalls?

Sadowsky: This is a politically charged issue and it would be very surprising to see Congress take any action – or inaction - that would negatively impact people already receiving Social Security. It is more likely that those who have not yet begun receiving Social Security benefits could be impacted.

For example, to extend funds it is possible that the retirement age for Social Security could be pushed out later so that people will have to wait longer before they can start receiving full monthly benefits. It’s possible this could impact younger baby boomers, but it’s more likely to impact the younger generations who still have quite a while before they are eligible to begin claiming benefits.

It’s also possible that we could see an increase in payroll taxes to support Social Security. It could be a small increase, or depending on the size of the tax hike, it could impact how much we have left to spend or save for retirement.

Boomer: What can individuals do to prepare for the possibility of Social Security benefits being reduced or pushed out?

Sadowsky: The burden of responsibility has certainly shifted more onto individual investors to provide for their own retirement.

Individuals should try to take advantage of employer sponsored retirement plans (such as 401(k)s and 403(b)s, since these offer the benefit of tax deferral, which could translate into faster growth of investments. And importantly, many employers will match employees’ contributions into these plans up to a certain threshold, so that’s almost like getting free money. Individuals approaching retirement age should especially ramp up their retirement savings by taking advantage of provisions that allow for catch up contributions.

Those who don’t have a 401(k) or other retirement plan – and even some that already do – can consider funding Individual Retirement Accounts, which also can provide tax deferred growth potential.

For those that want to supplement the lifetime cash flow stream that Social Security provides, an income annuity might be something to consider.  An income annuity is guaranteed by an insurance carrier to generate a recurring cash flow stream for as long as an individual is alive (or it can be structured for an individual and spouse). The guarantee is subject to the claims paying ability of the issuing insurance carrier.

And of course, outside of investing, individuals can plan for the possibility of reduced Social Security benefits by reducing how much they plan to spend in retirement and by planning to work longer in order to build more retirement investment or savings. Working longer would also help the individual to defer Social Security longer, and that would increase the monthly benefit available to him the longer it is delayed.