Retirees will see miniscule increase in Social Security benefits
Recently, the Social Security Administration announced the cost of living adjustments for 2017 benefits will be a mere 0.3 percent for retirees in 2017 over the benefits received in 2016. Social Security benefits are the primary source of income for many, if not most retirees today. That increase won’t amount to much for those receiving Social Security benefits.
In June, the trustees of the Social Security Trust Fund released their 2016 annual report to Congress. The annual report has gone relatively unnoticed, especially during the heated moments of the political campaigns of recent months. For many retirees and future retirees, as well as those on disability income, the financial status of the Trust Fund will impact future federal budgets, as well as the ability to fund benefit payments in the future.
The Trust Fund reports its assets are invested in special issue U.S. Treasury securities. The total assets reported in the 2015 annual report is approximately $2.8 trillion. In 2015, the income received by the Trust Fund was $920 billion, which included $93 billion in interest earnings, $795 billion in employee and employer payroll taxes and $32 billion in individual income taxes on Social Security benefits. Total benefit payments and administrative costs were $897 billion, which is a net surplus of $23 billion for 2015. If not for the interest income received and the income taxes collected on higher income recipients, the outflow from the Trust Fund wouldn’t exceed the payroll taxes collected. This non-interest deficit is expected to grow and rise sharply in just a few years, as the number of retirees grows significantly when compared to the number of employees working and paying into the Trust Fund. Just eight short years ago, the annual surplus was in excess of $100 billion.
As demographic change occurs, the Trust Fund will need to redeem its U.S. Treasury securities to fund benefit payments. Of course, that means the federal government will need to borrow the funds in issuing other Treasury securities, since there is no federal budget surplus to access. This will occur in 2035 for the Old Age and Survivors Income portion of the Trust Fund. At that time, there will be no net assets remaining in the Trust Fund and no interest income to be received on the special issue Treasury Securities. The Trust Fund will be completely dependent on payroll taxes and income taxes on higher income recipients. Since the benefit payouts will exceed the income in the years after the depletion of the Trust Fund, any shortfall likely will be dependent on having the federal budget make up the difference. If current deficit trends continue for the federal budget, the ultimate result may be borrowing more from the future to pay current benefits. Additionally, the disability income portion of the Trust Fund is expected to exhaust its assets by 2023.
The interest earnings on the Trust Fund’s U.S. Treasury assets provided a return of about 3 percent in 2015. This current return is obviously impacted by the low interest rate environment present in the U.S. Many of us have benefited from the low interest rate environment when we look at the rate of interest paid on our home mortgages. On the flip side, the low rate environment impacts returns on investments in securities tied to interest rates. The Trust Fund returns are lagging the returns most of us have seen in our 401(k) and other retirement plans or accounts.
The stock market performance in recent years has provided the higher returns on the qualified retirement plan assets. We all recall the political firestorm that occurred years ago when there was discussion to consider changing the investment mix of the Trust Fund assets. Given the controversy in the past on this topic, any change in the investment mix in the Trust Fund assets in the future is unlikely. If there is anything sacred in the federal budget, it is Social Security benefits.
What will the future hold for Social Security? This can has been kicked down the road for many years. The annual report certainly discloses the issues that are facing the Trust Funds in continuing the current path with no changes in either payroll taxes or the benefits to be paid. We have seen other benefit retirement plans face similar issues. Both private and public pension plan have seen similar demographic changes in the number of beneficiaries and those paying in to the plans. Without some changes in either the funding formula or the payout formula, the risk is some really tough decisions will need to be made later if some revisions aren’t made currently. Procrastination likely makes the issues more difficult to deal with later.
For some, other retirement savings will enhance any Social Security benefits to be received in retirement years. Retirement plans, such as 401(k), 403(b) and individual retirement accounts (IRAs), have accumulated some significant assets. The recent data released by the Investment Company Institute report IRA asset balances are approximately $7.5 trillion, and defined contribution plan assets, such as 401(k) plans, are approximately $7 trillion. Both of these amounts significantly exceed the $2.9 trillion the Social Security Trust Fund currently reports as its assets. The large amounts in these types of retirement accounts may become a target of those in Washington, D.C., as the national debt and possible Social Security shortfalls confront the country.
Currently, most of the IRA and defined contribution accounts are invested in securities other than special issue U.S. Treasury securities. This may provide returns in excess of the U.S Treasury return, albeit with some additional risk to the principal in those accounts. Unfortunately, many individuals do not have significant assets in such accounts. The median 401(k) balance has been reported as being less than $100,000. Balances in 401(k) accounts typically are the major retirement savings asset that most individuals own.
Additionally, many retirees’ financial positions may not be the same as in the past. In the past (reminiscing to the 1960s and ’70s), many retirees had fully paid homes with no outstanding mortgage debt. That is not necessarily the case today. In addition, many current and future retirees are counting on Social Security benefits as their primary source of retirement income.
In October, the Internal Revenue Service announced the maximum 401(k) limitation will remain unchanged for 2017 at $18,000. Most participants currently do not contribute at the maximum limitation amount and others fail to contribute enough to receive the maximum employer match. As 2016 draws to a close, decisions should be considered for 401(k) elective deferrals (contributions) for 2017. Those in employer plans should consider reviewing the limitations allowed by the IRS and reviewing the details in their employer plans. This may assist in the accumulation of sufficient retirement savings given some of the uncertainty of the Social Security Trust Funds funding and payout capacity into the future. After all, Benjamin Franklin summed it up best when he said “a penny saved is a penny earned”.
William Roth is a tax partner with the local office of international accounting firm BDO USA LLP. The views expressed above are the author’s and not necessarily those of BDO. The comments are general and not to be considered specific tax or accounting advice or relied upon for the purpose of avoiding penalties. Readers are urged to consult their professional advisers.