Wednesday, August 27, 2014 |
Joe Alfonso, Personal Finance Expert,

If you’re relying on the Social Security system to get you through retirement, you might have been confused by the annual report released recently by the system’s Board of Trustees.

On one hand, it showed that the system is running a $2.76 trillion surplus.

The bad news? Shortfalls are projected starting in 2033 if no reforms are implemented in the interim, though about 77 percent of the benefits will still be payable even then.

The reason for the projected shortfall is related to the fact that Social Security is a “pay as you go” system. Current workers pay into the system via Social Security taxes assessed on wages. This income is used to pay benefits for current retirees. The Baby Boomer generation is now in its peak earning years and its numbers exceed the number of current retirees. This means that there is more income flowing into the system than is being paid out, leading to an accounting surplus. This situation will reverse itself over the next 20 years as more and more Boomers leave the workforce.

Put simply, there will then be fewer workers supporting more retirees.

So what do these findings mean for those of us trying to decide when to begin taking our Social Security retirement benefits? Timing is critical when starting your benefit because taking it early (before full retirement age (FRA)) results in a reduction, while delaying until after FRA (up to age 70) results in a credit.

Here are six important points to consider:

1. Tune out the noise and don’t let fear cause you to make a poor benefit decision. The Social Security system is solvent and not in danger of running out of money any time soon regardless of what you may hear or read in the mass media.

2. While longer term shortfalls are projected, the changes required to address these are known and not complicated.

Unfortunately, gridlock in Washington will prevent action anytime soon, but change will eventually come, as it has in the past. Regardless of future changes to the system, these are unlikely to impact current and near retirees, except perhaps changes regarding how cost-of-living adjustments (COLA) are determined, but this possible change would impact everyone, not just a particular cohort of retirees.

3. Regardless of the short- or long-term prognosis for Social Security, taking early benefits always results in a benefit reduction and these are permanent and typically cannot be undone.

4. It is important to view Social Security as longevity insurance and as a hedge against running out of money in retirement. Unless you have good reason to feel that you have a shorter-than-normal life expectancy, delaying to maximize benefits is good insurance.

5. The effective rate of return on delayed Social Security benefits, assuming normal life expectancy, is impressive especially when compared to Treasury Inflation Protected Securities (TIPS) etc., in today’s low-rate environment. It therefore pays to tap into other sources of income while delaying Social Security to earn a higher guaranteed benefit.

6. Consider working with a qualified advisor to calculate the lifetime cost, assuming reasonable longevity, for taking early benefits and the breakeven age for delaying. This helps take emotion out of the picture and promotes good decision making.

In addition to being an annual financial accounting to Congress, the Trustees Report can be seen as a tool to help focus the Social Security benefit-claiming decision on fact and thereby avoid making decisions based on misinformation or emotion.

It is typically a mistake to take early Social Security benefits, short of extenuating circumstances such as life-shortening illness or a lack of additional sources of retirement income. We are all living longer and it is not unusual to survive well past 90. The shortfall in cumulative lifetime income due to a reduced benefit could therefore easily reach into the tens of thousands of dollars.

Sure, death can come sooner but what you are insuring against is the risk of living longer and possibly running out of money too soon.

Given the unique nature of Social Security income and how complicated the system’s rules are, it is important to make informed claiming decisions. All retirees would do well to manage Social Security as a valuable source of retirement income given how it keeps pace with inflation and lasts for a lifetime.

Doing so could be one of the best financial moves you will ever make.

This Article Originally appeared in the Business Section of GoLocalPDX