Why a 20% Cut Isn’t a Total Loss and How to Prepare

You've probably heard the headlines that Social Security is going to be "bankrupt" in 2034. For many, this sounds like an absolute disaster, but the reality is far more nuanced. Today, I'm going to take a look at what actually happens to your benefits when the trust fund is depleted, and I'll review four ways you can adjust your retirement plan with these changes in mind.

The Social Security "Bankruptcy" Misconception

The Social Security Administration has to pay whatever incoming payroll taxes bring in, but nothing more. When the trust fund is depleted, incoming payroll taxes are still expected to pay about 80% of scheduled benefits. This means an automatic, across-the-board cut of 20% will happen if Congress doesn't act.

In real dollars, if you are currently expecting a $2,000 per month Social Security benefit, that would drop to $1,600, a $400 per month loss in your expected benefits, or almost $5,000 a year. This isn't a political choice; it's an automatic adjustment unless Congress takes action.

Four Strategies to Adjust Your Retirement Plan

While your benefits won't disappear, they will be significantly reduced on the current path. Here are four strategies to consider in your retirement planning.

Strategy 1: Act as If Your Benefits Will Be Cut

Let's work through a real example. Imagine someone who is age 55 and expecting $2,500 per month in Social Security at their full retirement age (FRA). With a 20% cut, their benefit would drop to $2,000 per month—a $500 per month loss.

To replace this lost income using the 4% withdrawal rule, this person would need an extra $150,000 in their portfolio. That's a significant chunk of money. What can they do?

• Save More: If they had 12 years until their FRA to accumulate that extra $150,000 (assuming a 7% market return), they would need to save about $700 more per month.

• Work Longer: If they work an extra two years, their savings get two more years to grow, plus they get two more years of retirement plan contributions, and they delay withdrawals. This could easily make up the shortfall without a dramatic lifestyle change.

Strategy 2: Do Nothing and Bank on a Fix

While this might sound lazy, it's not a bad bet given the historical context. The last major overhaul of Social Security was in 1983, which extended the fund's life by an estimated 75 years.

• Political Pressure: Social Security accounts for more than 50% of the income for about 38 million people. It's hard to imagine any politician or political situation that would allow a 20% cut, especially given that people over 65 account for such a large portion of the voting public.

• Most Likely Scenario: In my view, the most likely scenario is a combination of tax increases and modest benefit adjustments for future retirees, not for those currently retired.

Strategy 3: Build Your Own Replacement

Social Security provides inflation-adjusted payments for retirees. You could build your own replacement for the lost 20% benefits using inflation-adjusted investments.

• Solution: Treasury Inflation-Protected Securities (TIPS) could provide a similar income stream. You could build a TIPS ladder to provide steady, inflation-adjusted income.

• Downside: This is labor-intensive and loses the longevity protection that Social Security provides. If you build a 30-year TIPS ladder and live for 31 years, the payments just stop. With Social Security, the payments continue.

Strategy 4: Delay Your Benefits

This is a strategy many people overlook. Delaying your Social Security benefits every year after your FRA increases them by 8%. If our hypothetical retiree (with a 20% cut) waits until age 70 to file, their benefits will be right back to where they were before the cut.

• Trade-off: This strategy works if you have good health and longevity in your family, as you're essentially trading higher benefits for a shorter number of years. It provides great insurance in case you live a longer-than-average life.

Planning by Stage of Life

The best approach depends on what stage of life you're in:

• Age 50-55: Focus on saving more. You have the most time to adjust your plan and build additional assets. Frame it as saving your salary increases for a pain-free boost to your savings rate.

• Age 55-62: Consider working a little bit longer. This is often the most realistic adjustment for these people. Working a few extra years can make a huge difference.

• Already Claiming: You're probably in the "green zone." A political solution is most likely not going to cut your benefits.

Your Actionable Homework

1. Check your Social Security statement. Go to ssa.gov and make sure all of your earning years are on there, as any missing years will affect your benefits.

2. Calculate the 20% reduction. See how a 20% reduction would actually impact your expected benefits and your retirement plan.

3. Run a scenario retirement calculator. See what different combinations of saving more, working longer, and adjusting your investments can do for your situation.

At Barrett FP LLC, we offer expert financial planning on an hourly basis, focused entirely on helping you achieve your goals.

Learn more about how we can help you with comprehensive retirement planning and see if we're a good fit.