More Evidence Both Parties Not Far Apart on Fixing Social Security

As I wrote yesterday, when President Obama stated in last week's debate that there was not much difference between his views and Governor Romney's on how to address Social Security's long term funding problems, the Governor's "non-response" effectively agreed with the President.  They turned instead to a sharp exchange of different views over how to fix Medicare.  Why?  Because it is a much bigger problem to deal with.

Dean Baker, writing in the Huffington Post today, effectively makes the same observation while drawing a starkly different interpretation.  He raises concerns about those aspects of a potential fix that will weigh most heavily on beneficiaries, such as adjusting the cost of living formula, raising the Full Retirement Age, and adjusting (lowering) benefits for higher income seniors.  Obama has already acknowledged that some or all of these options may be on the table.  I am certain some writer on the right would make the same observation with the opposite interpretation: Romney will betray taxpayers by raising the tax rate or the tax cap.  In fact, a judicious mix of all of these fixes probably needs to be incorporated in any eventual solution. 

Sure, there will be much screaming and gnashing of teeth on both sides of the political aisle.  The point is that there is effective agreement among serious politicians on how to get a deal done.  And for all the moaning, none of the fixes will fall catastrophically on any group.  Once this is resolved, the changes - likely to implemented gradually over a long period of time - will hardly be noticed.  In 1983 they raised the Full Retirement Age from 65 to 67.  Three decades later the Full Retirement Age has moved all the way to 66 and won't get to 67 for another ten years.  Who do you ever hear complain about the fact that their retirement age is 67 while it was 65 for their parents?

Most importantly, once they do agree on the fix and implement it, Social Security will be a stable and reliable source of retirement funding as far as the actuaries can see.  Now, if we can just educate those approaching their sixties on how to make better Social Security claiming decisions...

Obama and Romney Agree on Social Security?

Wednesday's debate may have made the biggest news because of the general perception that former Governor Romney won.  However, lost in this coverage was reporting on how they clarified their differences on what to do about Social Security which - to hear politicians and pundits talk about it - is heading over a cliff.  So how did they respond when Jim Lehrer asked to start off segment three on entitlements: "First — first answer goes to you, two minutes, Mr. President. Do you see a major difference between the two of you on Social Security?"

President Obama's response:

"You know, I suspect that, on Social Security, we've got a somewhat similar position. Social Security is structurally sound. It's going to have to be tweaked the way it was by Ronald Reagan and Speaker — Democratic Speaker Tip O'Neill. But it is — the basic structure is sound."

For the rest of his comments, the President drilled down on significant differences over Medicare.  Moreover, in former Governor Romney's response he didn't mention Social Security in any substantive way, basically providing tacit agreement with the President's assertion that some tweaking needs to be done.  Of course, on the subject of Medicare there was plenty of rebuttal and counter-rebuttal.

This provides considerable support to my ongoing assertion that the problems Social Security faces over the long term can be fixed and both parties understand quite well the alternatives that will get us there - the "tweaking" to borrow from the President's words.  Sure the solutions will be bitterly argued  - isn't everything in Washington nowadays? - and some toes will be stepped on.  Still, the fact that it wasn't worth 30 seconds of time in a ninety minute debate tells us volumes about how shallow the gulf is between the parties on this subject.  Will the tax rate or tax cap be moved higher on current workers?  Will the retirement age be raised?  Will the cost of living adjustment be lowered?  All these will pinch workers and/or retirees.  However, a pinch here and there is far less painful than the massive cuts or tax hikes needed to solve our other fiscal problems like Medicare, Medicaid, and the debt.  Compared to those, the Social Security problem is worth about 30 seconds of the candidates' time.

Scarey Numbers? Social Security, meet Fiscal Cliff!

Bruce Krasting makes quite a bit out of the fact that Social Security will pay out over $65 billion in benefits this month.  Writing in Business Insider yesterday, he makes the inevitable comparison to the GDPs of various countries and combinations of states. I found this comparison particularly interesting:

"The 2012 bill for SS will exceed the cost of the military, that’s the first time this has happened."

Like that's a bad thing?  To spend more on seniors, the disabled and survivors than on the military?

Now, it is a lot of money by any measure, and his larger point is to underscore the shortfall of income to cover the spending: while the shortfall last October was $6.7 billion, it rises this October to about $8 billion.  And, it will continue to rise as more and more Baby Boomers claim their benefits.  He characterizes this as a slow and steady erosion of the program, like sand from a beach. 

Although the "erosion" is gradual, it is well understood by the actuaries at the Social Security Administration who understand with considerable precision how the funds will flow over the coming decades.  Most importantly, the fixes are well understood, can be implemented gradually and we have two decades to work with.  Not so scarey really. 

Contrast this with the fiscal cliff arriving in three months when the Bush tax cuts and the payroll tax holiday will expire raising everyone's taxes as much as $536 billion according to this article at CNN.com.  Couple this with the $1 trillion over 10 years of automatic cuts negotiated in the debt ceiling bill last year and you have a formula for sucking what little energy there is out of an economy that is barely limping along.  Pretty scarey!  Of course, there's nothing like a fiscal cliff to focus the mind, whether Republican or Democrat.  Hopefully they will reach a compromise that all the politicians hate.  This is usually good news for the middle of the roaders.

More Abuse of Social Security Statistics...

Making reference to the average Social Security benefit is an often used - and misused - characterization that won't go away.  Chuck Saletta of the Motley Fool writes the following at MSNBC.com:

The average Social Security payment to a retired worker currently sits around $1,234 per month -- or about $14,808 per year. For comparison, a full-time minimum wage job would currently pay $7.25 per hour -- or around $14,500 per year.

From there he goes on to argue that with such a low average benefit, the importance of savings to augment the benefit is all the more important.  Fair enough.  I am all for more savings for retirement.  However, for those nearing retirement there is limited time for the magic of compound earnings to pump up their savings.  By contrast, there is a sure-fire way to increase your guaranteed Social Security benefits: find a way to claim later!

Let's unpack the loaded 'average benefit around $1,234 per month'.  More than half of claimants start benefits at 62, the earliest possible age.  Most of the rest start within a couple more years, long before the latest claiming age of 70.  Let's suppose this $1,234 is typical of people claiming at 62 (and it is if you have a look at this data from the Social Security Administration, p. 352).  That benefit is reduced about 25% from what it would have been at age 66, Full Retirement Age currently.  If the same person waited to that age to start, the benefit would be $1,542, an amount that would be typical of an earner who made about $44,000 a year during their working career.  If the worker waits to age 70 to start, the benefit is 32% higher, or $2,035.  Now, suppose a married couple both earned that amount and are entitled to the same benefit.  Claiming at 70 their income would be $4,070 or $48,840 per year.  Harly makes them wealthy, though there are places you can live on that kind of income, especially since it would be tax free if you have little other income.  Of course, you need to get to age 70...

Social Security rules give this couple a little help to get there.  At age 66 the younger spouse can file a "spousal" claim based on the other spouse's work record and receive 50% of what that other spouse was entitled to receive at age 66 (even though both are waiting to age 70 to claim on their work records).  That's 50% of $1,542, or $762 for 48 months: an extra $36,576!  Waiting has its own reward!

Getting the Most Out of Your Social Security Investment

The Social Security Administration periodically updates its analysis of the real rate of return that benefits generate for workers, male and female, at various income levels.  In its most recent report, from July of this year, the calculated rates of return are considerable, especially for low to moderate income earners whose returns range between around 3% and 6%.  Interestingly, even if benefits are cut in 2033 (when the Trust Fund is exhausted and assuming the only payments are from current payroll tax collections, a cut of about 25%), the range of returns for these earners is 2% to 6%.

In general, the returns go down for more recent generations.  Those born in the 1920s and 1930s have by far the highest rates of return.  Also, the returns for women are higher in all categories because on average they live longer and therefore collect longer.  Still, even high earners get real rates of return above zero under all scenarios.

I became aware of this analysis from an article by Steve Vernon writing at CBSNews.com.  Mr. Vernon writes often about Social Security and excels at explaining some of the intricacies of claiming strategy.  As he points out in the article, "Looking at all the various combinations, large numbers of hypothetical workers received estimated real rates of returns of 2, 3 or 4 percent per year."  Considering there is a near zero risk on this "investment", that's not bad!

One assumption used in their analysis deserves special notice from our vantage point: all calculations are based on the beneficiaries retiring at age 65.  Our own analysis shows that most of these claimants would enjoy far greater cumulative lifetime benefits if they claimed later, closer to age 70.  The result for most couples would be an increase in benefits approaching or exceeding $100,000, an amount that would increase the rate of return considerably.  Make the most of the investment you made in the Social Security system by adopting a smart claiming strategy.

Retirement in the Age withOUT Defined Benefit Pensions

A new study from the Center for Retirement Research at Boston College by Alicia H. Munnell, Rebecca Cannon Fraenkel, and Josh Hurwitz reveals just how poorly baby boomers are positioned for retirement in light of the shift to defined contribution pension plans (401(k)s principally).  According to this research, in the model a worker who reaches peak earnings of about $65,000 at retirement, and who put away 6% per year with an employer match of 3%, would accumulate about $363,000; a two-worker household with both earning the same would have double that.  Yet the Federal Reserve's Survey of Consumer Finances indicates that in 2010 a typical household close to retirement age only had about $120,000 in 401(k)s and IRAs - enough to purchase an annuity of about $575 per month.  (Presumably this is not an inflation-adjusted annuity like Social Security.)

Why the discrepancy?  First, there are a large number of businesses that don't offer 401(k) plans in the first place.  Second, of those that do off plans the participation rate of 79% is not as good as might be hoped.  Further, workers don't always maximize their participation.  For these reasons, overall only 42% of the private sector workforce participates in such a plan.  (The public sector workforce effectively has 100% coverage.) 

This data further underscores the importance of finding a strategy for waiting to claim Social Security benefits until age 70 when they are typically 76% higher before adjustment for any inflation).  Locking in the higher benefit level for life is undoubtedly the single biggest step to take to ensure greater financial security.  This is particularly so for those who are near retirement age and have few other options for accumulating financial wealth.

How Urgently is a Fix Needed for Social Security?

Charles Blahous is a public Social Security trustee.  He recently wrote a lengthy article, Is it Becoming Too Late to Fix Social Security's Finances? posted at Economics21.org, that emphasizes the necessity of acting sooner rather than later to shore up Social Security.  He points out that assuming there is plenty of time to act since the Trust Fund is not forecast to be exhausted until 2033 is a dangerous illusion that lulls too many into inaction.  If we fail to act soon, then the steps needed to right the program will be overwhelming.

He argues that the magnitude of the long run shortfall is close to 4% of the tax base (worker wages).  To put this in context, right now the tax base is taxed at the rate of 12.4% with 6.2% withheld from the employee's check and 6.2% paid by the employer.  Increasing the tax rate 4% would bring the total tax up to 16.4%.

He also compares this shortfall to the 1983 shortfall and concludes that it is about twice as severe. Moreover, he points out how politically difficult it was to agree to the changes made to fix the program at that time.  Such a degree of compromise in the current climate in Washington, D.C. seems highly improbable, in his view.

Dale Coberly responds at Business Insider to Mr. Blahous's article by arguing that such an increase (4%) isn't as mathematically implausible as it seems.  With real wages forecast to increase over time at roughly 1% per year, a 20% gain over 20 years could absorb the 4% (net real gain slightly under 16% instead of 20%).  If such an increase were implemented gradually, it might hardly be noticed.  This of course assumes the politics are overcome in order to get there from here.

I hope Mr. Blahous is incorrect about the politics and that some alignment of the stars will force the politicians to act.  However the issue is resolved it is as unlikely to be all tax increases as it is to be all cuts.  (The default solution is to cut benefits across the board around 25% in 2033.)  Simpson-Bowles had a mix of the two built in; you can view a PDF of the evaluation of the Simpson-Bowles proposal by the Office of the Chief Actuary at the Social Security Administration at a link provided in the Charles Blahous article.  I expect something along the lines of Simpson-Bowles to be closer to the eventual solution.