Can We Count on Social Security?

Most who are near or past the retirement starting line have some basic personal and business planning goals to preserve their cherished personal independence and dignity, to not outlive their money, and above all, to never become a burden for their loved ones. These basic goals raise a host of issues. We discuss one of the big ones in this post.

Can we really count on receiving the Social Security payments we’ve been promised? After all, we’re constantly being told that the program will go broke in a few years and then quickly become an impossible burden for our children and grandchildren.

For many, their retirement planning is a little scary. Their productive years are now in the rear view mirror. The numbers just stoke the fears. Surveys repeatedly confirm that today, the average retirement savings for a person north of 50 is $60,000. So there’s a risk. Actually, it’s a virtual certainty that many are going to outlive their money. Add to this a sheer knowledge that 1 in 8 of us between the ages of 65 and 85 will suffer from dementia – a loss in mental capacity that wipes out all independence, and the percentage jumps to 50% for those over age 85.

Of course, on top of all of this, there is the raw fear that has gripped all of America and most of the free world, as we have witnessed our economy plunge into a deep recession and chronic unemployment skyrocket, while our government continues to haunt the future of all Americans by spending at a pace no one could have imagined just a few years ago. Who would have thought 2009 would rack up a $1.4 trillion deficit (over 3 ½ times the size of any annual deficit we had ever seen in the past)? Or that our leaders would be projecting ongoing near trillion-dollar annual deficits for the next decade? These deficits and the rapidly mounting federal debt they pile on to have everyone scared.

What are all means for those crossing the retirement threshold that perhaps now, more than ever, planning for the final phase of life is critically important if you want to preserve your independence and dignity, not outlive your resources, and not become a burden for others? This article has only one purpose – to help educate retirees and soon-to-be retirees who want and need more information.

In this mini Social Security discussion, we’re going to focus on the challenges of Sue and John Jones who are both aged 66. Sue retired 4 years ago. John hung it up last year. They have 3 adult children, all married, and 5 grandchildren. John and Sue’s objectives are similar to those of most: make everyday count, reduce money-related stress, spend and live wisely, never outlive their money, always be a support, not a drag on their kids and grandkids, and plan smart for tragedy and any burdens triggered in their final days.

Can we really count on receiving our Social Security? It’s an important question because most have counted on receiving their promised Social Security benefit for decades. And now that the time is at hand, those promised benefits had become a big deal. Periodically, we have all received one of those official Social Security statements – laying out our earnings record and an estimate of our monthly benefits.

But as all who read the fine print know, these official statements also contain 2 scary warnings. Warning 1: The Social Security system is facing serious financial problems. Warning 2: Congress has made changes to the law in the past and can do so at any time. Beyond these warnings, there is a ton of confusion in the media with some saying social security will go bust in 2014; others predicting that the big bust won’t come until 2037 or 2041; and still, others claiming that the current recession has trigged the ugly crossover point right now.

It helps to understand the basis of this confusion. In a nutshell, even when these warnings and the scary numbers, the answer to this basic question probably is yes, you can count on getting your promised benefits if right now you are at or past the retirement starting line. But you should understand the basis of this belief, why it could turn out to be wrong, and most importantly, why those benefits, even if they’re paid to you, may not mean as much as you think.

The starting point in any Social Security discussion is to clearly understand that you have no legal rights to your promised benefits. In the famous 1960 case of Fleming vs. Nestor, our Supreme Court held that a laborer acquired no property rights to Social Security benefits by paying into the system. Any projected benefits can be reduced by Congress at any time. And Congress has reduced benefits in the past. So, nothing is legally walked in.

When Social Security was born as part of Roosevelt’s New Deal for the American people in 1935, the life expectancy for the average American was only 64 years, and middle and low income Americans paid no income taxes. The politicians of the day imposed a modest payroll tax on all working Americans to fund Social Security. They knew most Americans would never collect much, if any, benefits. By the 1970s, Social Security benefits were rising faster than wages, and the whole system was projected to go bust by the early ‘80s.

In 1982, a bipartisan commission appointed by President Reagan and headed by Alan Greenspan was formed to save Social Security. The result was a sweeping bill in 1983 that accelerated billions of future tax increases and increased the normal retirement age from 65 to 67 over an extended period of time. Reagan and his congressional buddies proclaimed victory, claiming that Social Security would be solid until at least 2068. A major component of the ’83 saving legislation was the promise that huge surpluses would be generated during the years preceding the retirement of the massive baby boomer group that 76 million of Americans who will start hitting age 65 in 2011. These huge surpluses were to be used to fund the boomer benefits, and as Reagan promised, they would ensure that those benefits would never be a burden for the boomers’ kids and grandkids.

Now, the payroll tax hikes have come as promised. They have risen every year. The tax has always been simple and mean. In 2010, the tax is 15.3% on the first $106,800 of earnings off the top, before any income taxes. For big earners, the tax drops to 2.9% on earned income in excess of $106, 800. There is a cap each year on the amount of earnings that are subject to the full 15.3%. This income cap goes up a little each year just enough to keep pace with increases in the income of middle America. So, this tax is not a big deal for the rich. Its spite is deluded as their incomes escalate. But for low and middle income America, the tax is a killer much worse than the income tax.

Like most retirees, John and Sue paid their payroll taxes for over 4 decades against the promise that their promised monthly benefits would be paid when they retire. The payroll taxes paid on their income over the years exceeded by a large margin the total amount of income taxes they paid during their earning years. That’s the case for 80% of working Americans.

The high payroll taxes paid by John, Sue, and all others produced huge surpluses for the government just as Reagan, Greenspan, and all others promised in 1983. Trillions of dollars of excess payroll taxes have been collected over the last 26 years to pre-fund the benefits of the baby boomers. What happened to this money, where’s it at – that’s part of the big con; what many call the deceit, the show game, the fraud. Every dime of this money generated from a flat rate tax imposed on labor earnings of primarily low-end and middle America has been used to pay general operating expenses of the federal government unrelated to Social Security. The promised reserve has been blown. What Social Security has to show for these blown surpluses are IOUs from the federal treasury. These IOUs are an official promise from the federal government that all these blown surpluses plus all interest that accrues on them will be paid back to the Social Security trust fund in the future when the money is needed to pay Social Security benefits. That is, when the baby boomers start stepping up to the plate to collect their promised benefits.

And where will the government get the money to pay these IOUs plus interest in the future? You got it. Future tax increases. And who’s going to pay these future tax increases that will be necessary to pay off the IOUs that represent taxes already paid in collected ones? Primarily, the young of America with some big help for many retirees who are collecting their benefits.

The bottom line is that the government’s plan for the boomers boomerang. This plan hatched in 1983 to pre-fund the Social Security burden for the baby boomers was from the very start a gimmick, an accounting scheme, a show game, as many call it, that has allowed the government to shift a big part of its current operating budget onto the backs of lower and middle income working Americans while shifting the full future funding burden for all retirement benefits for the boomers to future generations. Plain and simple – it’s a disgrace.

So what does this shameful history mean for John and Sue and all others retiring these days? For starters, it explains the confusion on the dates our politicians often throw around. Since 1983, more Social Security payroll taxes have been collected every year than benefits paid out. But that gravy train is about to end by 2014 as projected by the Social Security trustees last year, and some now say that the dreaded crossover point has already been hit with the job losses resulting from the current recession. So instead of providing a slush fund for other government expenses officially called the “off-budget surplus,” Social Security will now start sucking up federal money as the government starts paying off those huge IOUs to fund the current benefits for the retiring boomers.

It is the enormity of these big government IOUs which now amount to trillions that allows many, including the White House, to claim that Social Security benefits are safe until 2037 or 2041, depending on the assumptions relative to interest rates. So the comfort any current or near-term retiree has right now is in those IOUs. We can only guess as to how the government is going to fund the IOUs. Likely, it will just pile on more public debt. But since they are back by the full faith and credit of the United States, no one seriously doubts that they will get paid somehow. No politician from the very top to the very bottom will dare jeopardize reelection by messing with those IOUs and the promises they hold for the massive boomer vote.

So as long as those IOUs are paid, anyone at or near the Social Security trough should be safe. The ultimate burden, of course, will be felt big time by the young of America, our kids, and our grandkids. It will be a double hit. They will have to pay the bulk of the increased taxes to fund the IOUs – a payment of an old enormous debt that benefits only the boomers. Plus, their only hope for Social Security down the road is to substantially reduce, really drive down benefit promises to our kids and grandkids. Plans are already on the table to actuarially save Social Security by cranking up the retirement age for young Americans and substantially reducing benefits by changing the wage-based method of calculating the benefits.

So, plain and simple, our kids and grandkids will pay a lot more and get a lot less. But even if the boomers get all of their promised benefits adjusted for inflation, the benefits may not mean as much in the future in terms of purchasing power. The reason is the income tax bite on the payments. For a married couple, if the amount of their other taxable income plus one-half of their Social Security benefits exceeds $32,000. They have to pay income taxes on half of the Social Security benefits. If for a couple like John and Sue that has such a combined income that exceeds $44,000, they have to pay income taxes on 85% of their Social Security benefits. Even though the Social Security benefits themselves are increased for inflation, these taxable income thresholds are not. The result is that inflation continually forces more retirees into the taxable zone.

Twenty years ago in 1990, only about 12% of retirees had to pay income taxes on their Social Security benefits. Twenty years later, by 2010, inflation had pushed the income tax paying percentage to 31%. Basic projections indicate that as inflation continues to work its magic, over 51% of all Social Security benefits will be subject to income taxes within the next 20 years by 2030. But things could get much worse much faster if the federal government continues to rack up trillion dollar deficits every year, and the total federal debt continues to balloon. Many more retirees will find themselves having to send right back to the federal treasury 30% or 40% of their Social Security benefits in the form of income taxes or new value added taxes. And don’t, for a minute, think that the government won’t be counting on those increased taxes from Social Security recipients. Nobody, not even those receiving Social Security benefits will be able to escape the pain of annual trillion-dollar interest tabs on a mammoth federal debt.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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