The retirement columnist and Social Security guru discusses the pandemic's implications for retirement planning and how to ensure Social Security's solvency into the future.
Our guest this week is Social Security and retirement planning expert Mary Beth Franklin. Mary Beth is president of RetirePro and a contributing editor to InvestmentNews. She's a frequent public speaker and she also has her own podcast, "Retirement Repair Shop." In addition to her deep knowledge about retirement planning, Mary Beth is a virtual encyclopedia on the ins and outs of Social Security, especially beneficial claiming strategies. Her most recent book is Maximizing Social Security Retirement Benefits: Everything You Need to Know to Get the Most Out of Complicated New Claiming Rules. Prior to joining InvestmentNews, Mary Beth was tax editor at Kiplinger’s Personal Finance and a Capitol Hill reporter at United Press International. She has also earned the Certified Financial Planner designation.
Mary Beth Franklin bio
Mary Beth Franklin InvestmentNews article archive
Mary Beth Franklin on Twitter
Mary Beth Franklin Retirement Repair Shop podcast
Pandemic Impact on Retirement, Social Security Planning
“Rethinking Retirement Amid the COVID-19 Crisis,” by Mary Beth Franklin, InvestmentNews, May 10, 2020.
“Americans Remain Confident about Their Retirement Prospects,” by Mary Beth Franklin, InvestmentNews, April 29, 2020.
Withdrawing Your Social Security Application, SSA.gov.
Suspending Your Retirement Benefits Payments, SSA.gov.
“Pandemic Prompts Some to Rethink Social Security Claiming Strategy," by Mary Beth Franklin, InvestmentNews, April 7, 2020.
“Escape Hatch for Workers Claiming Social Security Early,” by Mary Beth Franklin, Investment News, April 22, 2020.
“Taking Social Security in the Pandemic: What to Know,” by Mark Miller, The New York Times, April 17, 2020.
“Social Security Has a Quick Cash Solution,” by Mary Beth Franklin, Investment News, May 19, 2020.
“Coronavirus-Related Relief for Retirement Plans and IRAs: Questions and Answers,” IRS.gov.
“Few Use CARES Act to Tap Retirement Savings,” by Mary Beth Franklin, InvestmentNews, June 10, 2020.
“How to Fund a Social Security Delay,” by Mary Beth Franklin, Investment News, Aug. 11, 2017.
“Wade Pfau: The 4% Rule Is No Longer Safe,” by Wade Pfau, Christine Benz, and Jeff Ptak, The Long View podcast, April 29, 2020.
“Using Reverse Mortgages in a Responsible Retirement Income Plan,” by Wade Pfau, Retirement Researcher.com.
“Senior-Housing Communities Face Higher Vacancy Rates Amid Coronavirus,” by Peter Grant, The Wall Street Journal, May 12, 2020.
Tax Planning and Retirement
“Stimulus Package Has Helpful Provisions for Retireees,” by Mary Beth Franklin, InvestmentNews, April 1, 2020.
“RMD Rollover Relief Granted Under CARES Act,” by Jeff Stimpson, Accounting Today, June 23, 2020.
“Now Is the Time to Convert Your Traditional IRA to a Roth,” by Rodney Brooks, U.S. News & World Report, April 3, 2020.
Social Security Claiming
“Coronavirus Is Closing Social Security Offices: Here’s How to Get Benefit Help,” by Mark Miller, The New York Times, March 17, 2020.
My Social Security
Social Security Retirement Estimator
"Your Retirement Benefit: How It’s Figured," SSA.gov.
“Social Security and Survivor Benefits,” by Mary Beth Franklin, InvestmentNews, Feb. 27, 2020.
“Social Security Claiming Strategies for Married Couples,” by Mary Beth Franklin, InvestmentNews, Feb. 21, 2020.
“Social Security Strategies for Singles,” by Lynnette Khalfani-Cox, AARP.org.
“Social Security Surviving Divorced Spouse Benefits,” Benefits.gov.
“Social Security Widow(er)’s Insurance Benefits," Benefits.gov.
Social Security Financial Health
“Social Security Funding Still Set to Run Out in 2035,” by Mary Beth Franklin, InvestmentNews, April 22, 2020.
"No, You Won't Lose All of Your Social Security Benefits," by Steve Vernon, Forbes.com, April 22, 2020.
The 2020 OASDI Trustees Report
Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance for Morningstar, Inc.
Jeff Ptak: And I'm Jeff Ptak, global director of manager research for Morningstar Research Services.
Benz: Our guest on the podcast today is Social Security and retirement planning expert Mary Beth Franklin. Mary Beth is president of RetirePro and a contributing editor at InvestmentNews. She's a frequent public speaker, and she also has her own podcast, "Retirement Repair Shop." In addition to her deep knowledge about retirement planning, Mary Beth has a virtual encyclopedia on the ins and outs of Social Security, especially beneficial claiming strategies. Her most recent book is "Maximizing Social Security Retirement Benefits--Everything you need to know to get the most out of complicated new claiming rules." Prior to joining InvestmentNews, Mary Beth was tax editor at Kiplinger Personal Finance and a Capitol Hill reporter at United Press International. She has also earned the Certified Financial Planner designation.
Mary Beth, welcome to The Long View.
Mary Beth Franklin: Thank you, Christine. It's always delightful to have a chance to talk to you about some of our favorite topics, money.
Benz: Right. We're thrilled that you're here today. So, much of your work focuses on retirement planning, and we wanted to start talking about that as it intersects with the pandemic and current recession. For older adults who would like to still work but have suffered job loss or at least some kind of income disruption through this period, what can they do? What's top of mind for you when you're talking about this cohort in terms of keeping their retirement plans on track?
Franklin: Certainly, people who have the option of working longer--that is a great opportunity to keep your retirement plans on track because it does several things. You continue to have money coming in. You are probably deferring having to tap any of your retirement investments. So, that allows them to rebound if they took a dive in the early volatile market stages. It also allows you to delay claiming Social Security benefits until they're worth more later, up to the maximum benefit at age 70. So, lots of good things there.
But the reality is, it's not always our choice when and if to retire. And we know that at the peak of the recession that was caused by the pandemic, there were 40 million people out of work. Now, a lot of those have gone back. And unfortunately, some may never go back. For those people who are 62 or older who are among those people who have lost their jobs, they have an added lever they can pull. They can claim their Social Security benefits.
Now, certainly, if you claim benefits before your full retirement age, your benefits are reduced. And you need to be conscious of that. If you say “Well, hey, I just need the cash flow. I'm going to claim my benefits now.” Go ahead and do it. That's what you have paid all these FICA taxes all your life, but do be aware of certain consequences.
One, those benefits are reduced. If you died prematurely and are married, you could be leaving your spouse with a smaller survivor benefit. And there could be an impact of your earnings on your Social Security benefits. Those are the downsides. The silver linings, however, are there may be ways to claim benefits now to get that cash flow. And then if things turn around later, maybe you do get your job back, you could stop those benefits so they would start growing more in the future.
Benz: I think that that is something that a lot of people weren't aware of, this ability to put a pause on benefits. Say, like going back to the example of someone who has had some job loss, they claim Social Security benefits but then find a job. What are the options at that juncture if you effectively want to put the pause on? And it seems like there's implications in terms of you've got to pay it back, right?
Franklin: Well, there are two different do-over options. The first one that you alluded to--having to pay it back--that's known as “withdrawing your application for benefits.” And anyone can do this within 12 months of first claiming benefits. They withdraw their application by filing Form 521. But the catch is, they have to pay back any benefits they have received. And if anyone has received benefits on their earnings records, such as a spouse or maybe a minor dependent child or a disabled adult child, you'd have to pay those benefits back, too. Probably none of those are good choices if you have lost your job due to the pandemic, but there's a separate do-over option.
The first one you have to do within 12 months of claiming regardless of your age. The second one--known as “suspending your benefits,”--you have to wait till your full retirement age or later to do it. And when you suspend your benefits, you do not have to pay anything back. This is probably the better solution for people who have lost jobs during the pandemic. So, you can suspend your benefits at full retirement age or later. And what happens? The checks that you have been receiving stop. And if anyone is collecting on your record, like a spouse or a child, those benefits stop, too. But the benefit here is, now, those reduced benefits you were collecting, now start growing by 8% a year in delayed retirement credits up until age 70. That's when those very lucrative credits end.
Say you are 66 years old, you take benefits for a year, something happens, you don't need the money or get another job, you can suspend your benefits, say at 67, not pay anything back, then they're going to grow by 8% a year over three years, and that would boost your benefits by 24% compared to what you were claiming earlier once you turn them on again at 70.
Ptak: We're going to come back to Social Security. And it's very clear the encyclopedic command you have over the various provisions and rules. And that's why we're so eager to talk to you about it. But we also wanted to talk a little bit more about retirement planning. And so, my question is: The CARES Act loosened the restrictions, as you know, on 401(k) and IRA withdrawals related to COVID-19. Are we seeing lots of early withdrawals so far? And do you expect they could pick up from here?
Franklin: Those are great questions, Jeff. What we have seen so far--and these are from the plan administrators, third-party administrators, plan managers like Principal and Vanguard--they both put out reports in the past month that said, “Frankly, we were ready to go with these emergency distributions and loans, and we're just not seeing a lot of activity.” Less than 2% at the height of the activity according to Principal, and well below 1% according to Vanguard, which is the largest provider of 401(k) plans. So, these plan managers put out information to all the employers that sponsored plans and said, “Here's the paperwork. Let us know what you want to do. Do you want to make it easier for people to take loans up to the new larger amount of $100,000 instead of the previous $50,000? Do you want to have penalty-free distributions?” So many of the employers said, “Yes, absolutely. We are there to help the employees.” And then, everybody waited around. And they said there were a few outliers where people who may be panicking went ahead and took up to $100,000 out as the law allowed and are probably just sitting on cash. But the majority of people in 401(k) plans simply did not do anything.
Ptak: My follow-up question is, Do you think that's good? And there's a related question there: How would you stack up 401(k) withdrawals relative to other sources of emergency funding? It seems like in the past 401(k) loans were always ahead in the queue, but maybe not anymore.
Franklin: I think it's great that people have not taken advantage of tapping these retirement funds. Certainly, if you have no other options and you've got a chunk of cash sitting in your retirement accounts, this is a good place to take advantage of it. But I think a lot of it depends on your stage in your career and your earnings and your savings pattern. A lot of younger workers who may not have huge balances may not be aware that taking the money out is not just the $10,000 or $20,000 you're taking out but how much that is going to cost them in compound earnings over the life of the retirement plan.
Now, the liberalized borrowing rules do allow them to put the money back. People who are taking money out have up to three years to put the money back. And they're not paying any early withdrawal penalties. So, it's better than the standard rule, certainly. But I would encourage people if they have other options to tap those first. The first thing--and I think this is the biggest lesson that's coming out of the pandemic--is why everyone needs an emergency fund. I think the fact that the federal government jumped in so quickly with the stimulus checks--the $1,200 per person and extra for families with dependent children--was critical because so many Americans said that they could not come up with $400 if pressed in an emergency. And it shows that we were coming off the longest bull market in our history with record-low unemployment, the economy was going great, and boom, it stopped in its tracks. And so many Americans have nothing to fall back on except these stimulus checks.
I think two things are going to happen going forward. I think there's going to be a bigger awareness of, “Yeah, we're really serious. You do need those three to six months of emergency funds that you can tap in a true emergency.” And that's for working adults. I think for people in or near retirement, they need bigger emergency buffers so that they don't have to start drawing down their retirement savings when the market is down. So, that's a really good lesson. And I think the other is: People thought they had great tolerance for risk for their long-term savings because they had seen their investment accounts go up and up and up and up. And suddenly, we hit this gut-wrenching volatility in March, and people now are perhaps rethinking that risk tolerance. There are some silver linings to come out of this, but they were certainly hard-learned lessons.
Benz: Do you have thoughts on rightsizing that buffer zone for people who are, say, close to retirement, within a couple years of retirement? How much is a good amount to have in cash? Or are there other sources of liquid reserves that you would direct people to just to cushion themselves in situations like these?
Franklin: When I talk to advisors who work specifically with people in and near retirement, a lot of them will say two to three years in cash. Now, that's a lot of cash. And the problem is, interest rates are at zero. So, that cash is not earning any money per se. Yes, you need cash, and I would look at some cash equivalents that are somewhat liquid. I know there are some of these brokered CDs that you might get through your advisor that are paying higher interest rates than what you would get at your bank. It's a tough environment for retirees who are reliant on fixed income because they're just not getting the returns that they once were. And yet, we've seen how important it is to have liquid assets.
I personally am a proponent of having some form of guaranteed income, whether it's a deferred annuity you purchased in your 50s with the idea it would grow regardless of what the market was doing if you had some sort of guarantees built in, so that when it came time to retire, you knew you had a certain amount of income regardless of what the market was doing. Frankly, I did that myself. I'm 65 now. About 10 years ago, during the Great Recession where we saw the market drop even more drastically, about 50%, but it was over a longer period of time, I said to myself at 55, “I do not want to be worrying about my equity investments when I'm 65.” And at that point, I did invest in a few deferred variable annuities with withdrawal guarantees. And lo and behold, now I'm 65 and we had this great disruption, and I know that a portion of my investments, which I have not tapped yet because I'm still working, will give me a chunk of guaranteed income. And that along with the Social Security benefits, which I have not yet tapped, will cover my fixed costs in retirement. I will stay invested because that provides my discretionary spending and future growth, because even at 65, you are still a long-term investor, and you are foolish to go all to cash because you do have to protect yourself against future inflation. We haven't seen a lot of inflation over the last 10 years or more, but that doesn't mean it's not coming.
Ptak: That dovetails with a recent conversation that we had with Wade Pfau, where he argued that current yields are the truly problematic piece of retirement planning, at least for the next decade. Do you agree? And if so, what are the implications for retirement planning? I think you just mentioned the imperative for guaranteed income. I suppose one could argue that with rates scraping rock-bottom--and the attendant uncertainty that that creates--that creates a stronger imperative for guaranteed income sources, but maybe you could expand a little bit on that based on what Wade had shared with us in our previous conversation with him.
Franklin: I am a big fan of Wade Pfau's work. And I think he's right when the 4% rule was developed about 25 years ago by Bill Bengen, just returns both on equities and fixed income were much higher. And the concept being that if you took out 4% a year your first year in retirement and increase that by the rate of inflation each year, in theory, that should last you through a 30-year retirement. Now, I know Wade has said, “Well, 4% is probably too high at this point. 3% is safer. Less is even safer.” And I have other advisors saying, “Well, duh, yeah, if you take out less, it is safer. But in reality, how can our clients live on less, depending on the size of their nest egg.”
So, as I mentioned, I like the idea of having some guaranteed income built into my retirement income plan. And I know Wade has always promoted the idea that, as the baby boomers are retiring, and we know so many of them may be undersaved from an investment standpoint, they may have to look at every asset they have--nontraditional assets or “buffer assets” as he called them--with the possibility of tapping them for income in the future.
For most Americans, they probably have more equity tied up in their home than they have in their 401(k). I'm not saying it's the first place you could go. But the fact is, many people may want to age in place and are sitting on a lot of untapped equity. And they may want to consider tapping that through a reverse mortgage. Now, I know those are fighting words in some circles--that they're expensive and they're complicated and gee, this isn't the best alternative. There have been a lot of consumer improvements over the years in reverse mortgages as far as protections for a nonborrowing spouse who might be younger than the minimum age 62, various things like that. But I think it can make sense, keeping in mind that any proceeds you withdraw from a reverse mortgage are tax-free. And I think, going forward, tax planning in retirement is going to be a bigger conversation. And I would argue that, as a result of the Tax Cuts and Jobs Act of--I've lost track at this point--was it 2017?--we are experiencing the lowest tax rates I think we will ever see in our lifetime. And these current individual tax rates are due to expire at the end of 2025. And I think people who have some flexibility that are in or near retirement, even those in their 50s, if they could start moving some of their tax-deferred retirement savings that are in 401(k) and IRAs and converting some of that money to Roth IRAs. And yes, you have to pay the current tax rates on the amount you convert, but you're creating a pool of tax-free income in the future. And that could be very important because I suspect in the future individual tax rates will go up. So, the bottom line for future retirees is not the income you're creating, but how much of it you get to keep.
Benz: Hold that thought on taxes, because we want to spend a little bit more time talking about the tax-planning dimension of this. But you mentioned, Mary Beth, aging in place and how a lot of people want to do it. And it seems like through this experience that probably a lot of older adults are really rethinking the idea of being in some sort of an institutional setting--as nice as some of those settings are. So, have you been thinking about that, whether we'll see radical changes in terms of where people want to live in retirement and the kinds of settings that they want to live in?
Franklin: Absolutely. I think the pandemic will have a huge change in how we think about retirement living and long-term care in the future. And I'm not sure we have the answers yet. But on two fronts, when you look at the incidence of the virus raging through vulnerable populations, it didn't matter if you were in a five-star luxury assisted living facility or a Medicaid nursing home. Those incidents of people getting sick and in many cases dying of COVID-19 were astronomical. The question would be if I'm in my 70s now, and I had been thinking about going into a retirement community, does that still make sense to me? The idea of some sort of communal retirement living situation may not be as appealing. And on a lighter note, as I mentioned, I'm 65. Many of my peers are about the same age. Most of us are still in our big houses where we raised children and often thought, “Well, you know, someday maybe we'll downsize to the two- or three-bedroom condo and minimize the lawn care.” Well, I'll tell you, I talked to a lot of friends who after being locked down with their mates for three months-plus are saying, “Oh, I am so glad we had three floors and four bedrooms to social distance from our spouses. I'm not sure I want to relocate to a condo after all.” So, that's a bit tongue in cheek, but I think a lot of people will be rethinking where and how they want to live in retirement.
I also heard from people that are classic snowbirds. “I live in Pennsylvania, but I spend the winter in Florida, and I rent for three months in Venice. And gee, it was great until the pandemic hit, and suddenly, the state borders are closing. I'm 1,000 miles from my family and doctors. Do I want to do this in the future?” I think people have a lot of things to think about, and I'm not sure we have those answers yet.
Ptak: Back to retirement planning. How about for people who are already retired and subject to required minimum distributions? They're able to pause their RMDs this year, and there's been lots of chatter that Roth conversions may be appropriate for them, too. What do you think?
Franklin: We had exciting news from the IRS just this week. We know that as a result of the CARES Act that required minimum distributions, for those people who had to take them-- and it depended your birth year, whether that was after 70.5 or 72--could take a pause of taking those required minimum distributions this year in 2020. And if they didn't take the distribution, then they're not paying taxes on those distributions. But there was a small group of people that were caught in a bind. When this guidance came out, it was originally in March and it went back to February and people had a little bit of wiggle room. But people who took their RMDs out in January were stuck. They didn't meet any of the requirements to put that money back. This guidance we got from the IRS this week says anyone who took any RMDs in 2020, if you didn't really want that money, you can put that money back. And you have that option through Aug. 31 this year.
I know a lot of people were quite happy, saying, “Gee, I didn't want to take the money out. I just did it because I had to, and now I have to pay taxes on it.” They can put it back. Another option is: OK, you took that money out, maybe you want to convert it to a Roth. Now, normally, if you're subject to required minimum distributions, you have to take that money first before you can do any Roth conversions, which could lead to a really big tax bill. But now that you don't have to take the RMDs, you could actually use that money to convert to a Roth.
Benz: How do you help people think about this? I sometimes hear from older retirees who say, “Am I too old to do conversions?” And I realize that a financial advisor with good financial-planning software can help figure this out, but sort of any profiles for whom a conversion would be especially attractive?
Franklin: First, it makes sense if you have money outside of your retirement account to be able to pay the taxes on it. Two, I think there's a lot of people from an estate-planning idea that their kids would much rather inherit a tax-free Roth IRA than a taxable traditional IRA or 401(k).
There are some things to think about. People who are higher income are subject to higher Medicare premiums as well. And for many of those people, it may make sense to convert some money to a Roth IRA and pay the taxes to create a pool of tax-free income in the future. And that way, they can look carefully when they're taking money out of various accounts--of not just the implication of what the income tax would be on the various amounts of withdrawing but what's going to happen to their Medicare premiums.
Right now, in 2020, most retirees are paying about $145 a month for Medicare Part B. But depending on your income, you could be paying close to $500 a month for Part B, per person. So, if the two of you are on Medicare and you're in a high-income bracket, that gets really expensive because you're paying a surcharge on Medicare Part B, which pays for your doctors and outpatient visits. And also, if you have a Medicare D drug program, there's a high-income surcharge on that. And then you probably have a supplemental Medigap plan. Your high-income clients could be paying $15,000 a year in essentially Medicare and Medigap premiums before they see a doctor or fill one prescription.
People in those positions might want to convert some of their traditional retirement accounts to a Roth IRA. This year could be a great time to do it when they're not subject to required minimum distributions. And we're still in relatively low-income tax brackets.
Ptak: Let's get back to Social Security, which we were talking about earlier. You're obviously incredibly well-versed in the ins and outs of Social Security. You've been reporting on the difficulties some people have had in filing for benefits and so forth because of the pandemic. Let's talk about that--some of the logistical issues that people have confronted as they've tried to get help.
Franklin: People generally like to go in person to their Social Security office. It just seems to make them feel better that, you know, I'm talking to someone face to face and they're walking me through this process. Well, since March 17, that has not been an option. The field offices all across the country have been closed, because protecting not just the employees of the Social Security Administration but their very vulnerable population of clients, who tend to be either older people applying for retirement benefits or survivor benefits or disabled people applying for disability benefits. So, virtually, all of the applications for benefits have either moved online or on the phone.
Things are getting better as the agency is adapting to these restrictions. But in the beginning, forget it, you call the 800 number, you might as well leave your phone off the hook for 24 hours in hopes that you'd get through. Frankly, I have been encouraging people for quite a while to file for their Social Security retirement benefits online. It's a very simple process. You follow the prompts at ssa.gov, which stands for SocialSecurityAdministration.government, and it's pretty straightforward. If someone is just applying for their own retirement benefits, you can do this in about 15 minutes. For someone who was born before 1954, technically the cutoff date of Jan. 1, 1954 or sooner--these people have a special ability that allows them to claim only benefits as a spouse, assuming they're married or divorced after 10 years, their own benefits growing, up until age 70. You can still do that online. And the reason I like to do that online is the computer doesn't mess up. Sometimes the in-person application process doesn't go quite so well.
If I go to ssa.gov, and I put in my basic information, my Social Security number, my address, my date of birth, any of the ID questions they are asking me to make sure it's really me, it's going to recognize my year of birth and my marital status, and it will say, “If you are entitled to your own retirement benefits and that as a spouse, would you like to claim spousal benefits only?” Click Yes. That's all you need to do.
In the prepandemic days, someone from the Social Security office would call you, after you had basically prepopulated this application and submitted it online, to go over your responses. Frankly, I don't know with their crush of work during the pandemic if they're still making follow-up phone calls. I honestly can't say if they're doing that or not. I think they're doing a tremendous job as they can under very trying circumstances. But people have to realize, it just will take longer than usual to do certain things.
Benz: Mary Beth, you often hear that you should review your Social Security's earnings history. They've got your track record of where you've worked and how much you made there. How often is it that someone finds something not right in those documents?
Franklin: I don't have any statistic to give you. One thing to keep in mind: Everyone, in my opinion, 18 or older who has ever worked, should have their own personal My Social Security account, which again you set up at ssa.gov. And right on the front page, it will tell you how to set that up. That way, you can access those estimated benefit statements that we all used to get in the mail, and most of us no longer do because it cost a lot of money to mail them out. But now you can access that information 24/7 that shows you your estimated Social Security benefits at the earliest age of 62, at your full retirement age, at age 70, and if you're married with a family, what your family benefits might be in the event of your retirement, your death, or your disability.
The other important part of that estimated benefit statement is it lists your earnings throughout your entire career and how much in those FICA taxes--those payroll taxes that support Social Security--you paid each and every year. I encourage people to go on at least once a year just to make sure that the reported earnings look like they're correct. When you work and your employer takes these payroll taxes out of your paycheck, they report to the IRS and SSA your gross earnings and taxes paid.
Let's say you know you made $85,000 last year and for some reason it says zero or it says some other amount. You want to check that and contact your employer and say, “Hey, this is wrong. This wasn't reported correctly.” Or contact the Social Security Administration: “Hey, this is wrong; we need to fix this.” Because your future retirement benefits are based on those reported earnings and you want to make sure it's accurate. The other thing is, you can only access those estimated benefits statements up until the time you claim benefits. Once you start receiving Social Security benefits, you no longer have access to that online account.
Ptak: The latest report from the Social Security trustees indicates that the Social Security Trust Fund will run out by 2035 if no action is taken to shore it up, and that doesn't even take the pandemic into account. The question is, how concerned should we be about the health of Social Security overall?
Franklin: That's a great subject to bring up, Jeff, and you are correct. The latest Social Security trustees report was compiled before the pandemic. It essentially said the combined Old-Age, Survivor, and Disability Trust Fund would run dry around 2035, which is the same estimate as the previous year. There are other think tanks that watch this closely, and they said, “No, probably it's going to be a lot sooner than that, possibly by the end of this decade, 2029.”
Why is that? Recession has a severe impact on the Social Security Trust Fund for three reasons. One, those payroll taxes--that we pay with every paycheck--is what funds Social Security. The money is specifically earmarked to fund Social Security. When you have 40 million people out of work, they and their employers are not paying FICA taxes, so, less money is going into the trust fund. Also, when you have a severe recession, you may have many people like we talked about at the top of this podcast, 62, 63, 64, who may have lost their jobs, and they decide they need to claim their Social Security benefits earlier than they had planned. So, more money is coming out of the revenues as well. And higher-income retirees pay taxes on a portion of their Social Security benefits. Maybe if their income is down because they lost a job or their investments are down, they might not pay any taxes on their Social Security benefits. And then, the final step, the Federal Reserve had stepped in to basically lower interest rates to zero to keep all the credit markets running, but that also means the securities where the Social Security Trust Fund reserves are invested are earning less money. So, it's a quadruple whammy really against Social Security Trust Fund. The problem, however, is still the same: That the way to fix it is either to get more money into the system or take less money out in the form of restructuring or reducing benefits or a combination of the two.
The thing about the Social Security Trust Fund is, since about 2010, our last recession, there was enough money prior to that from just ongoing FICA taxes to pay all the needed benefits. Around 2010, when we had a recession, we needed the money from the Social Security FICA taxes and money from the interest that was being earned on these securities to pay the benefits. But we weren't actually tapping the noninterest reserves. We're expected to start tapping that excess money that's been built up over the last 30 years, next year. And by 2035, if Congress does nothing and the reserves are depleted, there would be enough money from ongoing FICA taxes to pay about 79% of promised benefits.
Now, none of us is going to be satisfied with 79% of promised benefits. It would essentially mean a 21% across the board cut in benefits for everybody who is getting benefits. Now, nobody wants to see that happen. And I doubt Congress wants to see that happen because they know that old people who receive Social Security benefits tend to vote in higher numbers than the rest of the population. When this happened back in 1983, and I will add that I was a very young reporter for United Press International back in 1983, and I covered the Social Security reform legislation back then, and what they decided was, “Let's institute some changes, like let's gradually increase the full retirement age, which at the time was 65 to 67.” There was a huge outcry, “Oh, this is horrible; you can't change it.” Well, that was nearly 40 years ago, and that part of the legislation has not been fully implemented yet, because people born in 1960 or later, whose full retirement age is 67, that doesn't kick in until 2027. Congress gave us more than 40 years to get used to changes like a higher full retirement age and taxing some Social Security benefits for the first time and a few other changes like that.
The sooner Congress steps in to make needed changes, the easier it will be for the population to adapt. And I like to be the optimist and say, “If you had asked me in January 2020, could Congress get together to agree on anything? I would have said, ‘no way.’ “ But as a result of the pandemic and the crisis--we saw that in a crisis, our lawmakers actually can work together. And that does give me hope that Congress will address the shortfall of the Social Security reserves as soon as it gets the COVID problem under its belt, because it has demonstrated during this recession how incredibly valuable the guaranteed income of Social Security is and why it's imperative that they fix it for current and future retirees.
Benz: I have two follow-up questions on that. One, of the adjustments on the table related to Social Security--so for example, lifting the cap on Social Security tax or changing that or changing the age, means testing, other things--which of those do you favor? And then, also, which combination of those fixes do you think is most politically tenable at this juncture?
Franklin: Those are great questions. Again, I'm a proponent of phasing in changes over a long period of time. And I've heard a lot of talk, and it's controversial, of gradually raising the full retirement age, which is currently set to go to 67 to maybe 69 or 70. And people are aghast at that thought. But I'm saying for today's 2-year-olds, you know, frankly, they're probably going to live to 120. They'll get used to it. When you look at when Social Security was created in 1935, 65 was the full retirement age. In 2020, with the incredible increases in longevity we've seen for the average American--the average 65-year-old woman is going to live till 86; the average 65-year-old man is going to live till 84; and half of Americans are going to live longer than that--and yet, the full retirement age for Social Security benefit is only one year longer than it was more than 80 years ago, and it will go up one more year.
I think one could argue to gradually increase the full retirement age to 69 or even 70 with a very, very long lead-in time is feasible. Others would argue it's very important to keep the early retirement date of 62 because there are people in physically challenging jobs--construction, retail, restaurants, whatever--that physically just can't go beyond 62 to claim benefits. So, it's important to have that flexibility. Also, back during the 1983 Social Security reforms, at the time, the bipartisan commission on Social Security reform said, as long as 90% of U.S. wages were taxed for FICA purposes, Social Security would be financially fine in perpetuity beyond the usual 75-year look-ahead that they use for their analysis.
The problem is, so many people make so much more than the taxable wage base right now, which in 2020 is $137,700. If you make up to that amount, all your wages are taxed for Social Security purposes--6.2% on your side and your employer side. People who make more than that do not pay any additional FICA taxes for Social Security. They pay a very small portion, 1.4% or 1.5%, they and their employers, for the Medicare portion. So, as a result of this big gap of earnings, only about 83% of U.S. wages are being taxed for FICA purposes now, rather than the requisite 90%. If we gradually let that taxable wage base float up to 90%, and we're probably talking about $250,000 a year of wages, and then index for inflation after that, that--together with raising the full retirement age--solves the lion's share of the problem. Are they politically feasible? Well, basically, everybody is going to have to be unhappy in order to work a compromise. Generally, Democrats hate benefit cuts, and they consider raising the full retirement age a benefit cut. Generally, the Republicans hate tax increases. So, like in 1983, we'll probably have to do a little bit of both and make everyone equally unhappy.
Ptak: We often hear from retirees who say they don't want to delay because they're fearful. Notwithstanding your optimism, they're fearful about how the program will change between now and when they do file. How do you think some of the uncertainty that we've been talking about, how should this affect individuals' filing decisions, if at all?
Franklin: Well, it's a legitimate concern for some people. But I say if you're saying I'm going to grab my benefit at 62 because I'm going to get mine while I can and I'm afraid it's not going to be there, it's a bit like watching the stock market drop 35% in March and saying, “I'm going to cash out right now” in that all you have guaranteed is you have locked in your loss. But if it makes you feel better, maybe that's what you need to do. I would say to people who are thinking about claiming before their full retirement age, just be aware that if you do, your benefits may be permanently reduced because you claimed early. If you continue to have earnings from a job, this is not pension, noninvestment, but actual wages from a job and you claim before your full retirement age, you may lose some or all of those Social Security benefits, at least temporarily, because you're making too much money. And if you're married and you die, you may be leaving your surviving spouse with the smaller survivor benefits. Those are all the consequences of claiming before your full retirement age.
I don't have a crystal ball. I cannot tell you what Congress is going to do. In fact, I used to say that my crystal ball looks more like a snow globe at this point. I don't think anybody can tell you what Congress will do. But it's highly unusual for Congress to change benefits retroactively. I think you may see changes to some high-income beneficiaries. There is talk that they may change the benefit formula so lower-income people get a bigger benefit--and frankly, that's the way the system is designed already--and that higher-income people get less. I think it's very important that people, regardless of their income, get a Social Security benefit that they have paid for, because this is an earned benefit. I think if you turn it more into an income transfer, it becomes welfare for retirees and then, frankly, it loses its political clout.
I'd say, if you're scared--I can't tell you what's going to happen. If it makes you sleep better, go ahead and take it, but realize your benefits are going to be smaller. If you can wait till your full retirement age, do that if you can, because even if you're still working, the earnings restrictions go away, meaning you can continue to work and make as much money as you want and it won't affect your benefits. But for those people who have the luxury of being able to wait up until age 70--I say luxury in the sense of what are you going to do for money in between, maybe you're still working, that's great, solves the problem, or maybe you have other investments you can tap, another good solution, and you're healthy enough to be around--then wait until 70 is even more valuable in today's zero-interest-rate environment where the government is offering you 8% per year for every year you postpone your benefits beyond full retirement age up till age 70 and you can't get that anyplace else.
Benz: You just referenced the interplay between portfolio withdrawals and Social Security filing. And this was certainly top of mind during the first quarter when markets were sliding. So, in a situation like that, even though we often hear it's often better to pull from your portfolio sooner if it means you can delay filing, does that get flipped on its head, do you think, in certain environments if the only choice is to pull from a portfolio that has dramatically declined?
Franklin: Well, I think you'd have to look at the portfolio makeup there. Realistically, when you see these analyses, it sort of makes the assumption that the whole portfolio is in equities, and let's say, your portfolio has dropped 35%, that also sort of makes the assumption you are 100% in equities. Most retirees aren't in that situation. Did they have fixed income? Did they have bonds? Is there something they can draw from that they're not taking from the equity side of their portfolio if it's down? If that's not the case and they don't want to tap their investment portfolio and they're not subject to required minimum distributions in their retirement account, well, then it could make sense for some people to turn on those Social Security benefits instead.
The important thing is, these are just rules of thumb, and you have to look at Social Security as a piece of a bigger retirement income puzzle, and you're looking at the makeup of the other pieces of that puzzle in terms of specific investments and other assets and the person's health as well.
Ptak: What about younger investors or people who advise them? First, what do you say to the ones who say they're not planning on any Social Security at all?
Franklin: I do hear that a lot. I have two sons in their 30s. So, they are of that peer group. I tell them that it will be there for you. You pay your FICA taxes in; you will get a Social Security benefit in the future. It may not look exactly like the benefit your parents are getting. One of the big questions when we get to Social Security reform is, How will the benefit formula be structured? If, for example, they raise the taxable wage base that I was talking about earlier, so you're paying taxes on your first $200,000 instead of your first $137,000--presumably, that would also mean you would get a bigger Social Security benefit in the future. However, if lawmakers also tweak the benefit formula that wealthier workers are paying more into the system but getting less out in benefits in the future, well, then the onus is going to be more on people for their individual savings.
I think we're going to see much more engagement at the employer level on not just the retirement savings that have become so critical in what has turned out to be a very fragile safety network. But I think you're going to see more emphasis at the employer sponsor level of things like financial literacy, financial wellness, debt management, because I think for so many, particularly younger workers, their biggest issue during the pandemic was not so much retirement savings as emergency funds and getting out of debt. And frankly, all Americans need to learn these lessons that, yes, it's very important to save the future for your retirement, preferably doing it out of your paycheck each week or month, however you're paid, and just leaving that untouched, but you can't ignore your current needs, and putting an emergency expense on the credit card is probably not your best solution.
Benz: We wanted to spend the last few minutes here, Mary Beth, doing kind of a lightning round where we tap your experience about filing strategies and talk about a couple of profiles of individuals and couples and what is often the right filing strategy for them, understanding that this is obviously very individual-specific. I thought we could start with single people. It seems like when I've used calculators in the past to help loved ones with this issue, it often comes up with a delayed filing recommendation. Is that often the case for singles?
Franklin: Well, with singles, once upon a time before Congress changed the rules back in 2015, they did have some creative claiming strategies at their fingertips and those have disappeared. Basically, if you're single, truly single, I mean, not divorced, not widowed, but single, whenever you claim your benefits, that's the amount you're going to get based on your age at that time. You claim as early as 62, your benefits are going to be reduced. If you wait till your full retirement age, you're going to get your full retirement benefit even if you keep working. If you're able to delay till 70, you get a bigger benefit.
Now, does it make sense for a single person to delay until 70? It certainly means you would get a larger monthly benefit when you do claim and that may be a good solution to your retirement income needs. But there is a risk there that if you die before you collect the benefit, nobody is going to get a survivor benefit. You don't have a spouse; you don't have minor children. So, it can be risky for singles. I often tell singles, wait till your full retirement age. And then, if you want to claim Social Security, you don't need it, just bank it. If nothing else, use it to pay your Medicare premiums.
I think the idea of delaying benefits till 70 becomes much more important for married couples. And even in that case, I don't think both spouses should necessarily delay till 70. I do think it's valuable if one spouse, particularly the one with the bigger Social Security benefit, can wait until age 70 because, by creating the largest possible retirement benefit while both spouses are still alive, it also creates the largest possible survivor benefit when one spouse dies. A survivor benefit is worth up to 100% of what the deceased worker was collecting or entitled to collect at time of death. So, by having one spouse wait until 70, you've locked in this potentially bigger survivor benefit. And having said it, the other spouse may want to go ahead and claim early at 62 if he or she's not working or at full retirement age if they are, because it brings some cash into the household and takes away a bit of the sting of having the other spouse wait till 70.
The other profile that I want to stress, and this is so important, is people who are widows, widowers, or surviving ex-spouses who were married at least 10 years before being divorced. It's important for these people to remember that retirement benefits and survivor benefits are two different pots of money. And depending on their age and situation when they become widowed, they may be able to claim one type of benefit first and switch to the larger benefit later. It doesn't matter what year they were born. It's the fact that they have their own retirement and a survivor benefit. They could claim the smaller one first and switch to the larger one later.
Benz: Well, Mary Beth, I think we're going to have to leave it there. We always learn so much from you. Thank you so much for taking time out of your schedule to join us today. We really appreciate it.
Franklin: Thank you, Christine and Jeff. It was my pleasure to be with you today.
Ptak: Thanks so much.
Benz: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts. You can follow us on Twitter @Christine_Benz.
Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1.
Benz: Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.
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