Debt Deal: What Changes Might Be in Store for Social Security?
The devil's in the details of the debt deal. Say that three times fast and your tongue will get just as twisted as our politicians' did in recent weeks.
The recent debt compromise calls for a bi-partisan committee to make recommendations to Congress by Thanksgiving for reducing entitlements, including Social Security and Medicare. These programs are protected, however, from the automatic reductions in entitlements that will go into effect if the bi-partisan committee doesn't come to any agreement, or if Congress doesn't adopt their recommendations.
What could this mean for your retirement planning? Let's look at recent proposals to change Social Security benefits, to glean what this bi-partisan committee might recommend.
The following members of Congress recently made proposals that were subject to cost analyses conducted by the Office of the Chief Actuary of Social Security (I'm assuming a proposal is serious if a member of Congress requests such an analysis):
- National Commission on Fiscal Responsibility and Reform, the bi-partisan panel headed by former Senator Alan Simpson (R-Wyoming) and Erskine Bowles
- Sen. Kay Bailey Hutchison (R-Texas)
- Sens. Paul Rand (R-Kentucky), Mike Lee (R- Utah), and Lindsey Graham (R-South Carolina)
- Sen. Tom Coburn (R-Oklahoma)
- Rep. Cynthia Lummis (R-Wyoming)
- Rep. Peter DeFazio (D-Oregon)
It's seems pretty clear that for a bi-partisan committee to reach any agreement, changes in both benefits and taxes will be necessary. The committee's composition will give some good indications; if there are too many hardliners in either camp, the committee could easily become deadlocked on Social Security issues.
Let's examine in detail each of the changes under consideration.
Next: Proposed changes to Social Security's retirement ages
Retirement Age Proposals
The current Normal Retirement Age (NRA) is age 66, gradually increasing to age 67 for people born in 1960 and after. Your monthly retirement income is decreased if you retire before your NRA, and increased by delayed retirement credits (DRCs) if you retire after your NRA. Age 62 is the earliest age at which you can start Social Security benefits.
Under the various proposals, the Normal Retirement Age (NRA) would gradually increase from age 67 to:
- Age 69: Hutchison plan
- Age 70: Paul-Lee-Graham and Lummis plans
- Increase from age 67 according to improvements in longevity: Coburn and Simpson-Bowles plans
- Age 64: Hutchison and Paul-Lee-Graham plans
- Age 65: Lummis plan
- 5 years before NRA: Coburn and Simpson-Bowles plan
- Age 58: Hutchison plan
- Age 57 for NRA, age 53 for early retirement: Rand-Lee-Graham plan
- Age 52: Coburn and Simpson-Bowles plans
- Age 51: Lummis plan
It's pretty clear that Republicans favor increasing both the NRA and the early retirement age, while Democrats will resist this idea. It's also pretty clear that if any changes are adopted, people currently in their mid-fifties will be exempt.
My take: I give this one a low chance of passing now, but don't be too relieved. The reason: Due to the exemptions, changing the retirement age won't reduce entitlement spending for 10 years. AARP and other senior advocacy groups have vowed to fight any reduction in Social Security benefits that are part of a debt deal, but they might consider changes that could be positioned as strengthening Social Security. So there's little reason to take on this fight if it doesn't reduce entitlements in the near future. But it's possible these changes might stand a better chance of being passed in the years to come. I'd bet against changes that depend on improvements in longevity, simply because that's too complicated to explain and administer. If you're currently below mid-fifties, plan on retiring in your mid to late sixties or early seventies.
Next: Proposed changes to the method of calculating benefits
Proposed Changes to the Benefit Calculation Method
The Coburn, Rand-Lee-Graham, and Simpson-Bowles proposals all gradually change the methods under which Social Security calculates the monthly retirement income. These proposals are too complicated to explain here; the bottom line is that with all of these proposals, benefits for lower-paid individuals are protected while benefits for higher-paid individuals will be reduced. For this purpose, lower-paid individuals are defined as people whose career average earnings are below the 40th percentile; this amount was a little more than $30,000 per year in 2010.
Under the Coburn proposal, the changes would start for people turning age 61 in 2012. The Rand-Lee-Graham proposal would start making changes for people turning age 56 in 2012, and the Simpson-Bowles proposal would start changes for people turning age 52 in 2012.
My take: I believe this change also has a low chance of passing, for the same reason as the retirement age changes. That is, it won't reduce entitlements in the near future due to the exemptions for people currently in their mid-fifties or higher. However, these changes could be adopted in the future as part of an effort to strengthen Social Security. If you're below your mid-fifties and a high wage earner, I'd count on Social Security benefits that are reduced by up to 15 percent, with a greater reduction the younger you are today.
Next: Proposed changes to the cost-of-living adjustments (COLA)
Proposed Changes in COLA Adjustments
Coburn and Simpson-Bowles propose using chained-CPI as the method of adjusting retirement benefits for cost-of-living, which would reduce future COLA adjustments. The chained CPI method also got a lot of attention in the weeks leading up to the recent debt compromise.
Sen. Hutchison simply proposed to reduce the current COLA adjustment by one percent a year (for example, if the current COLA would increase benefits by three percent, under Hutchison the increase would be two percent).
The new COLA method would become effective in December, 2011 under the Hutchison and Simpson-Bowles proposals, and in December, 2012 under the Coburn proposal.
My take: Use of the chained-CPI has a good chance of passing, because this would immediately save money. For current and future retirees, I'd count on slower increases in Social Security benefits, most likely going into effect in December, 2012.
Next: Proposals to increase Social Security taxes
Proposals to Increase Social Security Taxes
Currently the Social Security tax is a combined employer-employee rate of 12.4 percent, applied to earned income up to the Social Security wage base of $106,800.
Rep. Peter Fazio (D-Oregon) proposed that the same Social Security tax rate also be applied to earned income above $250,000. Under this proposal, benefits would still be calculated using earnings up to $106,800.
Simpson-Bowles proposed to gradually increase the Social Security wage base to $190,000, both for the purpose of calculating taxes and for calculating benefits.
There have been many suggestions to increase the compensation that is subject to both taxes and benefit computation, and this suggestion is the most popular with the American people. This would cause a net gain to Social Security's finances, because the increase in Social Security taxes would more than offset the increase in benefits due to the higher wage base.
My take: Some increase in Social Security taxes for wealthy individuals could be essential for the Democrats to agree to any benefit reductions resulting from using the chained-CPI for cost-of-living adjustments. Watch for a bitter fight in the bi-partisan panel and Congress over this issue. In the long run, if you're a high-income individual, count on some form of higher taxes or lower benefits.
Considering all of these possible changes to Social Security, here are my conclusions:
- In spite of pessimism about the future of Social Security, it will still be there in its current form. Nobody is proposing to eliminate the system entirely, and no serious proposals are being made to move to an account-based program.
- It's still worth your time to figure how to get the most from Social Security benefits, regardless of any changes.
- Count on a gradual reduction in the amount of Social Security income, immediately for current workers and retirees through a reduced COLA, and possibly also through a change in the way benefits are calculated.
- If you're below your mid-fifties, count on retiring later to some time in your mid-to-late sixties or early seventies.
- If you're a high-income earner, count on higher taxes in some form.
More on MoneyWatch:
- Deficit Commission Proposals: What They Could Mean for Your Retirement
- Boost Your Social Security Payout by $100,000
- What You Need to Know About Social Security
- COLA Wars: Deficit Cutting Takes Aim at Cost of Living Adjustments
- The Truth About Social Security Cuts
- How the Debt Deal Impacts Your Retirement
