Bob’s Journal for 5/16/2019

Last update on: Sep 17 2019

The latest annual report from the Trustees of Medicare and Social Security sparked a lot of discussion, but many of the conclusions people made are wrong.

Every year, the trustees of Social Security issue a report to Congress and the public on the financial status of the program and its trust funds. You can find the 2019 report here.

The important trust fund for most of us is the Old-Age and Survivors Insurance trust fund (OASDI). This is the one that covers retirement and survivor’s benefits. There’s another trust fund for disability income.

Every year, the key headline for the media is the latest estimate of the year the OASDI is projected to drain its reserves, which usually is referred to as Social Security “running out of money” or “going broke.” This year’s estimate for the life of OASDI’s reserves is the same as it was last year. The OASDI trust fund is estimated to be depleted in 2034. That’s only 15 years away.

The annual cost of the program is expected to exceed all its income in 2020 for the first time since 1982. The cost is expected to exceed income every year for the next 75 years. (Each year the projections are made only for the next 75 years.) The cost of the program has exceeded its non-interest income since 2010.

While those are the main points, there is a lot of misunderstanding about exactly what they mean and how people should respond. Since the report was issued, I’ve talked to people of different ages who believe that Social Security benefits will end in 2034 for them and everyone else.

That’s not what the report indicates.

First, it’s important to note that the projections are based on a lot of estimates about economic growth, salary levels, tax collections, inflation and other factors. If the estimates are too pessimistic, the trust fund will last longer.

Second, the report shows that the trust fund, or reserves, will be depleted by 2034. You might recall that for decades Social Security taxes exceeded the benefits paid. The trust fund lent that excess money to the Treasury, which gave the trust fund special bonds. The trust fund will be depleted when all those bonds are cashed in.

Third, and most importantly, the program will continue to receive Social Security taxes indefinitely. Those taxes will help pay benefits each month.

The trustees estimate that these taxes will be sufficient to pay 77% of the OASDI benefits promised for at least the next 75 years.

The bottom line is that Social Security won’t die. But changes will be made, and your retirement plan should have some flexibility so you can respond to the most likely changes if they are made.

People already receiving Social Security retirement benefits are likely to be sheltered for the most part. The exceptions probably will be beneficiaries Congress considers to be affluent. It is possible that beneficiaries above a certain income level will face an outright benefit reduction, known as means-testing.

Some financial advisors say that people who have a retirement income of $250,000 or higher should assume their Social Security benefits will be eliminated. That’s probably the most drastic of the potential changes, but it wouldn’t surprise me if it happened.

There’s a higher probability that the formula for paying income taxes on Social Security benefits will be adjusted so that higher-income beneficiaries have more of their benefits taxed. Instead of a maximum of 85% of benefits being included in gross income, 100% of benefits will be included in gross income at some income levels.

Congress might even impose a special tax rate or surtax on Social Security benefits of higher-income beneficiaries that essentially reduces or eliminates their benefits.

To be safe, I’d assume that if your income is high enough for some of your Social Security benefits to be taxed today, your future plans should assume 100% of the benefits will be included in gross income starting around 2034.

I think there’s also a high probability there will be a reduction in the annual cost of living allowance (COLA). The COLA already is less than general inflation. The trustees report assumes benefits grow one percentage point less than general inflation each year.

Congress easily could adjust the COLA formula (as it did in the 2017 tax law for other inflation adjustments) so that benefits increase less each year than they do under the current formula. This change likely would apply to all beneficiaries, and I think it would take effect immediately after it is enacted.

People who are years from retirement now are likely to pay higher payroll taxes during the rest of their working years. They’re also likely to see the benefit formula adjusted so that they receive lower retirement benefits than under the current formula.

The bottom line is that Social Security retirement benefits aren’t going away. But after 2034, the system can pay only about 77% of promised benefits, if the trustees’ assumptions are accurate.

Affluent retirees receiving benefits at the time changes are made could face a combination of lower benefits and higher taxes. Future retirees should expect a combination of higher taxes during their working years and lower retirement benefits, with the changes affecting higher income people more than others. All current and future Social Security beneficiaries are likely to receive lower COLAs.

Because of Social Security’s financial condition, you need a cushion in your retirement plan. Most people should assume they’ll incur a combination of lower benefits and higher taxes equal to at least 20% of their estimated or current Social Security benefits. The higher your income and net worth, the higher that percentage should be.

The Data

Inflation, as measured by the Consumer Price Index (CPI), still isn’t giving the Fed any reason to keep raising interest rates. The CPI increased 0.3% in April and 2.0% over 12 months. Excluding food and energy, the CPI increased 0.1% for the month and 2.1% over 12 months.

Home builders report their business is improving. Builder confidence improved markedly, with the NAHB’s Housing Market Index rising three points to 66. That’s the highest reading since October. Last May, the index was at 70.

Another sign of an improving housing market is a 5.7% increase in housing starts in April. Also, March data was revised to show an increase in starts instead of the decline that initially was reported. Building permits increased by 0.6% in April after declining for three consecutive months. But most of the new permits were for multifamily housing. Permits for single-family homes declined for the fifth consecutive month.

The optimism of small business owners increased in April, according to the NFIB Small Business Optimism Index. It rose to 103.5 from 101.8. Most components of the index increased. Small business owners continue to report that their most significant problem is hiring and retaining qualified workers, and they anticipate having to increase compensation in the coming months.

Manufacturing is showing signs of recovering from its pause of recent months.

The first of the manufacturing surveys for May indicates manufacturing might be bouncing back from its pause of the last few months. The Empire State Manufacturing Survey increased to 17.8 from 10.1. That’s a six-month high and was propelled by large gains in new orders and shipments.

Likewise, the Philadelphia Fed Business Outlook Survey increased to 16.6 from 8.5. That was well above expectations. New orders declined but shipments increased.

But April still was weak for manufacturing, according to the Industrial Production report. Overall production declined 0.5% for the month and the manufacturing component also declined 0.5%. Motor vehicles and parts, as well as utility production, led the decline.

New unemployment claims declined by 16,000 to 212,000. That ends several weeks of higher claims.

The Markets

The S&P 500 lost 1.57% for the week ended with Wednesday’s close. The Dow Jones Industrial Average declined 1.43%. The Russell 2000 dropped 2.53%. The All-Country World Index (excluding U.S. stocks) fell 1.53%. Emerging market equities tumbled 3.09%.

Long-term treasuries gained 0.33% for the week. Investment-grade bonds rose 0.02%. Treasury Inflation-Protected Securities (TIPS) increased 0.42%. High-yield bonds fell 0.53%.

On the currency front, the U.S. dollar increased 0.04%.

Energy-based commodities rose 0.81%. Broader-based commodities gained 0.50%, while gold increased 1.06%.

Bob’s News & Updates

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Seriesclick here.

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I’m a regular contributor to the Forbes.com blog. You can view my contributor page here.

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