For years, advisers had little to worry about when it came to Social Security retirement income modeling for clients, at least in the short term. That is, the monthly benefits seemed stable for at least the next couple of decades. Indeed, as recently as 2012, the Social Security Administration was projecting full retirement benefit solvency through 2038. That was more than 20 years in the future, a political eternity in which to remedy the issue.

Suddenly that day of reckoning appears sooner. The SSA in 2016 lowered its estimate of the approaching insolvency to 2035. Moreover, the Congressional Budget Office, a non-partisan federal agency, projects an earlier date of 2029.

(Getty Images)
(Getty Images)

Although those estimates differ by only six years, the reasons behind the discrepancies are important. They not only highlight the impact of competing assumptions used in these complex economic models, but they also could change income projections for clients, even if that just entails adopting a more risk-aware perspective.

To be sure, all of this angst is assuming that there will be no changes to the program forthcoming from Congress. With a few relatively small changes, the system could be bolstered enough to pay full benefits for many more decades to come. Another important consideration: even if no changes are implemented, the system will not be financially broke. It would continue to pay out benefits based on incoming tax revenues, but ongoing program revenues at that point would only be able to pay about 79% of the scheduled amounts.

Still, in dealing with the situation as it now stands, clients will be understandably concerned when they hear “Social Security” and “reduced benefits” in the same sentence. Advisers need to be able to contextualize these issues, hear clients’ fears and help them focus on the bigger financial picture.

The largest single factor contributing to the alternative estimates appears to be differing projections of program revenues. The revenue difference, in turn, is primarily driven by different assumptions about the growing wage disparities between the upper 1% of wage earners and the other 99%.

Payroll taxes on wages are the far largest source (86%) of all Social Security revenue. Other revenue sources include interest on fund investments, and taxes on benefits. Wages are taxed, up to a maximum taxable amount ($127,200 for 2017), at a rate of 6.2% to the employee and another 6.2% to the employer. Self-employed individuals pay both portions. Above the annual maximum, tax is no longer deducted.

Not all states are equal when it comes to taxes and Social Security
Clients who want to reduce their expenses during retirement may want to move to a state that doesn’t tax these government benefits.

Total national wages subject to Social Security taxes, however, have been dropping steadily and are depressing program income. Ninety percent of all national income was taxed for Social Security in 1983 compared to only 83% in 2014, according to Keith Hall, the director of CBO, in September testimony to the US House of Representatives’ Subcommittee on Social Security. The reason seems to be the disproportionate rise in the wages of the upper 1%. In 1978, the top 1% of wage earners represented 6.8% of all national wage income, Hall said. By 2008, it rose to a shocking 13% of all national wage income.

Each year the annual maximum taxable amount is adjusted for wage inflation based on the average wage index of all workers. Theoretically this should track wage growth. However, with the income of the upper 1% rising more quickly than average, the wages of that population are increasingly being excluded from taxes because the wages are above the maximum taxable amount.

(Bloomberg News)
(Bloomberg News)

Both the SSA and the CBO agree on this point but differ in their projections. The CBO projects a continued drop of national wages subject to Social Security taxes, from 83% in 2014, to 78% by 2026. The SSA expects the percentage to remain steady at 82.5%.

Rising health care costs also contribute to the drop in Social Security payroll taxes. The CBO estimates that the percentage of total compensation paid in the form of earnings (which could be taxed) fell from 90% of compensation in 1960, to 81% in 2015. This was primarily attributed to the rising cost of health insurance and health care which are demanding a larger and larger share of total worker compensation.

There are other significant factors behind the disagreement in the projected date of program insolvency by the two agencies.

Varying GDP projections, for one. These are caused by the SSA projecting higher labor force participation, lower unemployment and higher productivity growth. Different demographic projections also play a role.

No matter what economic assumptions one uses, or which federal agency upon which one relies, the fact of impending Social Security insolvency and benefit reductions is clear. The complexity of the modeling process and significantly different projections by two respected agencies only highlights the uncertainty about the date of insolvency and should reinforce the urgency for political action to address the shortfall.

Advisers should take all of these projections with a grain of salt and consider a more conservative approach by assuming the earlier insolvency date for purposes of client planning. They should also be ready for client questions and closely monitor the political developments. This issue has been festering since the Bush administration and time is running out for some action before benefits get cut.