income taxes on future required minimum distributions.
Estimate a sustainable annual retirement spendingpath given the client’s current wealth and make a planto withdraw funds from a traditional individual retirement account to bridge lifestyle expenses before SocialSecurity begins.
Explain that by withdrawing the IRA assets when their
income taxes are lower, this allows for a reduction in the tax
impact of required minimum distributions later in life; with-
draw more before age 70 and less after Social Security begins,
while paying attention to tax brackets.
Keep in mind, waiting until age 70 may not be the optimalclaiming decision for everyone.
Jason Fichtner is the associate director of the Master ofInternational Economics and Finance Program at the Johns HopkinsSchool of Advanced International Studies. Michael Finke, Ph.D.,CFP, is a professor of Wealth Management and Frank M. EngleDistinguished Chair in Economic Security at The American Collegeof Financial Services.
the economic effects of the current COVID- 19 pandemic couldbe taken into account. The 2021 report is not due out untilApril 2021.
Using the 2008 financial crisis as a proxy, the BipartisanPolicy Center estimates that if the financial impact of the pandemic is similar to that experienced as a result of the 2008Great Recession, the Social Security OASI trust fund depletiondate would hasten to 2030, while the DI trust fund depletiondate would be dramatically sooner — moving up to 2024 tofrom 2065.
On top of the drop in payroll taxes from increased unemployment, President Trump signed an executive order to“defer” payroll taxes until the end of 2020. Social Security’schief actuary estimated that failing to reinstate payroll taxeswould deplete the trust fund by 2023, although the tax willlikely be reinstated and the deferred taxes collected in 2021.However, it is now very possible that the Social Security trustfunds will be depleted within the next decade, thus forcingcongressional action.
Is the government “raiding” Social Security? Not technically. Itis true that the federal government has spent the tax revenuesallegedly collected to pay for future benefits. But the Treasurybonds are guaranteed by law.
This means that beginning in 2021 when Social Securitystarts redeeming Treasury bond holdings in the trust fundsto pay scheduled benefits, the government will have to borrow from the public, raise taxes or cut spending to financethose redemptions.
Starting in 2021, it is likely Social Security will begin toredeem the trust fund bonds, at which time the government willhave to borrow even more from the private markets.
Though the borrowing need will increase gradually, the needto borrow an additional $2.9 trillion, the value of Social Securitytrust funds at the end of 2019, from the private market will beharder and harder over time.
The Medicare program also faces a funding shortfall, with themost recent estimates suggesting that the HI trust fund couldbe depleted in 2026.
Social Security Reform
There are, however, many reform options that will help achievesustainable solvency and do not raise taxes. For example,Congress can increase the retirement age, link benefits increases to longevity, and better account for automatic adjustments tothe benefit formula for changes in price inflation.
It is likely, however, that the government will be forced toinstitute some combination of tax increases on higher-incomeworkers and reduced benefits (or, more likely, a decrease inbenefit growth).
The Role of Financial Advisors
Financial advisors will need to help clients navigate the uncertaintyand risk associated with the impact that the impending depletionof the Social Security trust funds will have on retirement security.
While most Social Security experts doubt that Congress willlet benefits be reduced by 25% once the trust funds are depleted, it is very likely that both current and future beneficiaries willface meaningful reductions in lifetime benefits that could affectfinancial security in retirement.
For those people who are very risk averse, or for youngerpeople whose retirement is still decades away, financial advisors may want to consider planning advice to account for apotential 25% reduction in future benefits as a baseline worstcase scenario.
It is likely that more of the burden for paying for the trust funddepletion will fall on higher earners. Those currently makingmore than the wage limit may be subject to additional incometaxes during their working years.
Retirees may face higher taxes on earnings, and may also beasked to pay for a greater share of health expenses. Youngerhigh-income workers face the possibility of a triple whammy ofhigher payroll taxes before retirement, lower retirement benefits, and higher costs.
Strategies that shelter savings from income taxation, forexample through the use of tax-exempt Roth accounts andhealth savings accounts, could become even more valuablewhen the tax bill for funding promised benefits comes due.
—Jason Fichtner and Michael Finke