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Going for Broke

David Johnson

WHEN SOME FOLKS MAKE the all-important Social Security claiming decision, one worry outweighs all others. Their big fear: The program’s funding will “run out” in a few years and therefore they “can’t depend on Social Security being around,” so the smart strategy is to claim benefits at 62, the youngest possible age.

This is not a big worry of mine—largely because Social Security won’t “go broke.” What’s happening to the program’s funding is that, in the past, annual revenues flowing into Social Security from taxes on workers exceeded the cost of annual benefits that the program paid. Excess funds were used to purchase government bonds. As the population ages, and the percentage of retired workers rises, the revenue from current workers will drop below the benefits being paid to retirees. The shortfall at first will be made up by selling the government bonds the program has purchased in the past.

Social Security’s excess funds, called the Social Security trust funds, are projected to be depleted sometime between 2033 and 2035. In the absence of changes to the law, Social Security’s revenue will then be limited to the contributions of active workers. At that point, the stream of contributions to Social Security from current workers will still cover some 75% of benefits. Consequently, while the trust funds could be exhausted, the system can’t go entirely broke unless every single person in the country stops working.

There are several steps that policy makers might take to close the funding gap, and some of these have been done in the past: raise the Social Security withholding rate on all workers, delay the future full retirement age for current workers, or increase the income subject to Social Security payroll taxes. One thing that policy makers have never done is decrease the benefits for people already receiving them.

Even if you believe policy makers will dither and do nothing, it’s likely that your benefits would be around 75% of what current calculations suggest. If you aren’t counting on Social Security because of its funding problems, you could eliminate the risk of lower benefits by purchasing a deferred income annuity that would provide 25% of your Social Security benefit at whatever time in the future you think the system will “go broke.”

Paradoxically, it’s likely that you would find that the cheapest such annuity is simply to delay claiming Social Security itself by a little more than three years. After all, your benefit will increase by around 7% to 8% for each year you delay, and thus a three-year delay would give your benefit roughly a 25% boost. From a risk mitigation point of view, for those who can afford to wait, the possibility that future benefits will be dramatically reduced is not an argument for claiming Social Security early. Rather, it’s an argument for delaying benefits.

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