CHERENSON: How can we avoid the Social Security tsunami?

August 4, 2013 

A giant economic tsunami is closing in on the United States. Unless there is significant change soon, this devastation will suck the life blood of our nation.

This tsunami is our Social Security obligation. Several suggestions have been made to prevent the catastrophe. I have one that is a little different.

We all know how Social Security works; or do we? The Social Security Administration was established in 1935 under President Franklin D. Roosevelt to help provide income for retirees. At that time half of seniors were considered to live in poverty.

A tax was established on income generated during one's working career. This has remained the basic mechanism through the years.

Currently, we all pay 6.2 percent of our income into the pool, which is matched by 6.2 percent from our employers. Self-employed individuals pay 12.4 percent of their incomes.

This pool is FICA, the Federal Insurance Contributions Act tax, and it is the largest portion of payroll taxes.

Funds collected today are paid out to current beneficiaries, with surplus funds invested with the U.S. Treasury in the Social Security Trust Fund. FICA tax is paid on all income up to a specified earnings level, which in 2013 is $113,700. This wage limit increases annually.

The Social Security monies provide revenue for old age (retired seniors), survivors and disabled individuals. To qualify for retirement benefits, during your lifetime you must pay into the system for a minimum of 10 years. Individuals today may begin collecting benefits as early as 62, but waiting to full retirement age (66 or later) results in higher monthly benefits.

The retirement benefits received are derived from a complicated formula which is applied to the 35 highest years of reported earnings over your working life (The Social Security website provides extensive data, including a benefits calculator Individuals not qualifying receive no benefits. The current highest monthly payment is $3,350. The average recipient currently receives a monthly benefit of $1,250.

For very low earners Supplemental Security Income is available as well, up to $710 monthly. SSI funds do not come from FICA taxes, but rather from the U.S. Treasury via income taxes.

A basic understanding of this complicated system is required to comprehend the tsunami and possible solutions to prevent the devastation, including a new and novel idea!

Social Security benefits are financed by a pay-as-you-go system. Taxes paid today by those still working fund payments to current beneficiaries.

The problem with the "pay-as-you-go system" is there are currently 2.91 workers paying in for each individual collecting benefits. But due to changing demographics this ratio will decrease to 2.0 by 2030.

Approximately 10,000 baby boomers are beginning to collect benefits daily, and citizens are living longer, hence collecting benefits for more years. The average beneficiary is collecting many more dollars than he or she ever paid into the system.

Using an individual who paid in on the maximum wage base limit for all 35 years and assuming this individual waited until age 70 to collect benefits, they would have paid $164,000 into the system, being matched with an additional $164,000 by their employer(s). This is a total of $328,000 in lifetime contributions.

Assuming they live until 80, they will collect $402,000. If they live until 90 they will collect $804,000 and if they collect until 95, they will derive $1,050,000 in lifetime benefits based on $328,000 of lifetime contributions. These return rates are more profound for lower wage earners, as proportionally, they collect significantly more on their contribution.

If we do nothing we will exhaust the trust funds, run an extreme deficit in the program and either bankrupt the nation or force many more seniors into poverty. This is the tsunami.

The good news is there are many options to implement before the tsunami arrives. Current ideas include:

1) Further increase the age of retirement

2) Decrease monthly benefits

3) Increase the payroll tax rate to 8 percent

4) Increase the wage base limit significantly on higher earners

5) Means test wealthy individuals, decreasing payments to them in accordance with their financial position, and

6) Encourage young people to save and invest today to provide for retirement.

Basically it comes down to charging more and-or collecting less.

The biggest problems associated with these six options are:

• The vast majority of people find it extremely difficult to live on Social Security benefits alone

• Most people do not save enough in retirement planning to complement their Social Security payments and sustain a modest and decent lifestyle for decades, and

• The attitude of "touch someone else's benefits, but not mine."

Unfortunately, Americans have evolved into believing that we have all been paying into an annuity that will provide a guaranteed monthly benefit that grows with cost-of-living adjustments. This is simply not true. The original intent of this program in 1935 was only to help keep the poorest seniors from experiencing abject poverty.

Additionally, most Americans do not have the financial literacy, ability or discipline to invest for 30 plus years to provide for their own full retirement. Wall Street has also ripped off many Americans with predatory fees and at times abysmal returns.

There is another possible solution to the Social Security tsunami. What if beneficiaries collected lower benefits early in retirement and substantially more as they age?

As an example, rather than receive $1,250 when they retire, what if a senior began by collecting $750 a month, and then that amount rose by $100 per month for each subsequent year. If you collected for 25 years, your final monthly payments at the end of your life would be $3,250. (Social Security benefits increase, but only according to the rise in the Consumer Price Index.)

When we first retire most of us can probably work at least part-time. Most people are not ready to become completely sedentary at 65. Additionally, most people have probably accumulated the most wealth they ever will by this age.

The challenge for those fortunate enough to have saved for retirement is trying to plan and make your wealth last the rest of your life which is an unknown. Additionally, the costs of staying alive probably will increase beyond the cost-of-living increases due to long-term health care problems. Medicare and Social Security do not pay for long-term care.

The upsides to this new backend load system would be:

1. You can still collect payments at an age young enough to reap the benefits you have paid into

2. If you burn through your savings, you would have an increasing system of financial support when you need it most

3. You can continue to work on a part-time basis when you are able, and can be confident that your income will increase to make up for the difference as you slowly withdraw completely from the workplace

4. The highest benefit amounts will be delayed and fewer people will collect the highest level of benefits because some won't live that long. Those who live a very long life will be more secure.

5. Overall, with proper financial forecasts from actuarial experts, this system is likely to decrease the total payments from the government and avoid the tsunami.

We have time to avoid the economic tsunami rolling toward the United States. Hopefully we have the political will to be proactive and use common sense.

Cherenson is a Turlock veterinarian and a resident who has studied the Social Security obligation in detail.

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