Should You Include Social Security in Your Retirement Plan?
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The Social Security program currently pays more in benefits than it collects in revenue. If no changes are made, Social Security will become insolvent by the year 2034 and all beneficiaries, regardless of age or income, will face a sudden 22% cut to their benefits.

This situation and the corresponding headlines in the media have, rightfully so, caused many retirement savers to worry. It's also caused them to wonder if they should include Social Security income in their retirement planning projections.

Almost 70 million Americans collected Social Security in June of 2020. 97% of them were elderly. And the analysts at Boston College found that future anticipated Social Security benefits represented 60% of the average wealth for middle-income Americans between the ages of 55 and 64.

Needless to say, a large chunk of the American population relies on this program, and while the average Social Security benefit of around $1,500 per month likely won't make or break a lot of the retirement plans of our listeners here, it's money that you and your employer contributed throughout your working years and money that you'd probably like to see back in your pocket, as promised.

Plus, even if you don't think you need Social Security to retire with confidence, it does help provide a buffer for some of those unknowns in life that we just can't plan for. For example, what if you have one of those rare, extreme, long-term care events that cost well above what you planned and self-funded for? Or what if we go through a 10-20 year period where investment returns are flat or even significantly lower than the assumptions in your financial plan?

Knowing that you have social security income as an extra source of cash can make a lot of people feel extra comfortable about officially hanging it up and retiring, which leads a lot of retirement savers to ask, should I include social security in my retirement plan given that the program is likely to become insolvent? Before I go any further, just a quick note that if you'd like to grab the episode links and resources mentioned today, just head over to youstaywealthy.com forward slash 136.

So let's begin answering today's big question by first covering the basics of how the Social Security program works. The primary source of revenue for the Social Security program comes in the form of taxes on those in the working world. For example, employees and employers each contribute 6.2% of the employees' wages for a total of 12.4%.

If you're self-employed, well, you're both the employee and the employer, so you pay the entire 12.4%. Now, as you might know, there is a limit on earnings that can be taxed by Social Security. In other words, if you make, let's say, $500,000 per year, well, you aren't paying 6.2% or $31,000 in Social Security taxes. There's a limit to the earnings that can be taxed.

In 2021, that max limit is $142,800. So the most that can be contributed on your behalf this year, including both your contribution and your employer's is about $17,700. Next year in 2022, the max limit goes up to $147,000, meaning the total max contribution on your behalf is just over $18,000.

For many years, Social Security's revenues were higher than their expenses, which created a surplus. And that surplus is and was invested in U.S. Treasury bonds.

The interest that was earned that is earned on those bonds is another source of income for the social security program. Those surplus years are well behind us now. In August of this year, the social security board of trustees shared an outlook that was even worse than last year's projecting again, that annual costs would exceed income and the cash reserves would therefore be depleted in 2034, rendering the program insolvent. Now,

Just because cash reserves are depleted doesn't mean that all Social Security payments just stop and the program disappears. Remember, those cash reserves were built up due to a long run of years where the program had a surplus.

Even without cash reserves and the treasury bond income that's received on those reserves, even without those cash reserves, annual revenues are still earned from the social security taxes being paid by working Americans and their employers and would be sufficient to pay about 78% of the program's costs in 2034, which is projected to decline to 74% by 2095.

In other words, in this scenario, all beneficiaries of Social Security payments, regardless of age and income, would immediately have their benefits cut by 22% by the year 2034. The alternative and the more likely solution is that there's some sort of reform to the current system as it stands today.

The simple answer to how do we fix social security is to increase taxes or reduce benefits or some combination of the two. The actual detailed proposals to accomplish one or both of those solutions are, of course, all over the map. While most have both advantages and disadvantages and will no doubt spark some heated political debates, here are some of the more popular proposals that we've seen. The first is Rehabilitation.

raising the full retirement age. Right now it's age 66 or 67, depending on when you were born. Well, some have suggested raising it to 69 or even 70. Also, some have taken issue with cost of living adjustments and how they're calculated. So they're proposing that we either lower those COLAs or change the calculation method.

Also, a more controversial solution is to reduce or strip the benefits entirely for higher income earners who arguably may not need Social Security income in retirement. Obviously, again, a very controversial solution there.

Another is increasing the percentage tax on wages. Some have suggested bumping it up two percentage points from that 12.4% number I shared to almost 15%. And then lastly, increasing the maximum income limit, which is happening next year in 2022. As mentioned this year, it's $142,800. And then next year it jumps to $147,000.

So if they continue to increase that maximum income limit, that will put more revenue in the program's pocket as well. So going back to the big question that we're trying to answer for today's episode, which is not how to fix social security, but should you include social security in your retirement plan?

The first thing I think about is what is the worst case scenario? And there are two of them, at least in my mind. One is that you have sizable income in retirement or you're projected to have high income and let's just say $250,000 of taxable income or higher.

you would be part of the approximate 1% of retirees who could be stripped of their entire benefit. Again, this is obviously a complex and controversial solution, but it is a solution that's regularly tossed around, so we have to at least consider it, especially if we want to be extra safe with our planning. So if you expect to have sizable income in retirement and you want to plan for this worst case scenario, then I would not include Social Security income in your retirement plan projections.

Now, removing Social Security entirely might feel a little too conservative, so the other potential worst-case scenario is to consider that there is no reform, that nothing happens, and your benefit is reduced by that 22% number by the year 2034. In fact, it could even be more than that by some projections, so perhaps you factor in a reduction of 30% in your retirement planning projections just to be safe.

This podcast, as a lot of you know, caters to successful retirement savers who are nearing retirement or in it, but I do know that we have a subset of younger professionals as well. And if that's you, it might be wise to remove Social Security from your planning altogether or plan on collecting it closer to age 70 or even later and at a reduced benefit amount.

If you take this approach, just know that you're not alone in feeling this way. According to a recent research poll, roughly 50% of Americans under age 50 believe they won't receive any social security benefits at all. But given that you do have a lot more time to plan on filling this retirement income gap,

Removing Social Security from your planning should prove to be less of a burden for you than someone who's retiring tomorrow. I'm not saying it's the right solution here, the right thing to do, but it is easier for you to plan because you have a longer time period ahead of you. And hey, if Social Security is reformed intelligently and you end up receiving a healthy percentage of your benefit, well, it'll just be icing on the cake for you and your retirement.

Contrary to what the headlines might scare you into thinking, Social Security is not going away. The most likely outcome for the Social Security program is that there's some combination of increases to the full retirement age, the cap on wages, and the percentage tax on wages.

If you enjoy nerding out on this topic and you have some opinions here and you want to play around with some of the different options to reform and fix Social Security, I'm going to be linking to this interactive free tool that allows you to see how your desired proposals stack up and play out in real life. And I'll be linking to that in the show notes, which once again, you can find by going to youstaywealthy.com forward slash 136.

Thank you as always for listening, and I will see you back here next week.