The Sustainability of Social Security and What it Means For You (EP.159)

0:27We all need to make smart decisions with our money. in a way that builds on our previous two episodes. In episode 157, we talked about what it means to be a reserve currency and why the U.S. dollar holds its dominant reserve currency position. And in episode 158, we built on some of those ideas and introduced important concepts from modern monetary theory to better understand our country's national debt. Now, in my opinion, there are few topics as broadly misunderstood as U.S. government spending. And as a result, many of the conversations around Social Security from a policy perspective are off the mark.

1:08I also think people lack the appropriate context for Social Security in their financial plan and their personal investment portfolio. So that's the goal of this episode, to help you understand how to think about Social Security within your financial plans and personal portfolios, but to do so we must first understand the financial well-being of Social Security, as well as the potential policy changes that could impact the future of the program. President Franklin D. Roosevelt signed the Social Security Act in 1935 as part of a system he believed could provide financial security for everyone in the country, and as he put it, from the cradle to the grave.

1:51Because this was a massive financial proposal, FDR wanted to reinforce the idea that Social Security was self-sustaining, and so the Social Security Act of 1935 tied the payment of benefits to a payroll tax. We are all familiar with the FICA line on our paychecks, which, by the way, stands for Federal Insurance Contributions Act, and most people think of Social Security benefits as being funded purely from the revenue that payroll tax generates. In the Social Security Act amendments of 1939, FDR established a trust fund that invests the revenue from the FICA tax that isn't needed to pay out benefits in any given year, and that money gets invested into U.S.

2:37Treasuries. This further reinforces the idea that payroll taxes from working people, rather than the federal government as a whole, are supplying the cash that keeps Social Security afloat. The other notable component of the 1939 legislation was the establishment of a board of trustees tasked with projecting out Social Security's fiscal solvency 75 years into the future. Now, I've had countless guest interviews and solo episodes on points making it clear that we as a species are bad at predicting the future. It's hard enough to predict what will happen one year from now or 10 years from now, but I think we all need to take a moment to realize that a 75-year projection on things like population growth, the number of people working, changes in wages, economic growth, inflation, etc., that's a lot to predict.

3:37These predictions also create unnecessary political frictions as current reserves within the trust for Social Security are projected to run out by 2035. And herein lies the mistake FDR made. He hoped that people seeing the money available to pay benefits would make the Social Security program more politically viable. However, everyone can, quote, see today that the money isn't there. And while the existing surplus FICO withholdings that are credited to those trust funds will keep the system together for a while, eventually the fund accounts will be empty. And once the trust fund accounts are empty, benefit cuts will be triggered.

4:21But not because the government can't afford the payments. No, no, no, no, no. It's because Congress wrote a law that says it will not pay full benefits if the balances of the trust funds ever fall below zero. In other words, we do not lack the financial ability to pay, but the legal authority to pay. This is where listening to the prior episode on the U.S. national debt could be helpful, because as we've already established in that episode, the United States government can always pay its bills because they can simply print as much money as they need. Deficits and the national debt don't really matter because the risk of default is effectively zero when you can print your own money.

5:08The real risk of printing too much money is inflation. But more on that when we get to talking about financial planning and personal investing implications. So Congress could fix Social Security's solvency problem by simply rewriting the law. Why haven't they done so? Well, to date, most politicians seem to think that the best way to preserve the program is to shore up the trust funds so that the 75-year projections can show it as fiscally sustainable. But they could simply write the law the way Medicare law is written. Within Medicare, there are two trusts, one for supplementary medical insurance and another for hospital insurance.

5:52Now, while the hospital insurance, that trust faces long-term financing shortfalls, the projections for the supplementary medical insurance, aka Medicare Parts B and D, remain healthy because it has the legal authority to pay full benefits if the trust funds are ever exhausted. And it's really that simple. Social security should only be considered at risk of insolvency because the government hasn't yet committed to making the payments. Because all we ever hear is that, quote, social security is going broke, end quote, most people don't realize that the choice to fix the problem is really just a political one and not an economic one.

6:38So what are some of the potential changes to Social Security on the horizon. Even though rewriting the laws governing Social Security financing and payments would completely erase the issue of solvency, I think it's more likely that legislation is passed to reduce benefits and that has real implications for your financial plan. I'm going to just share a few of the most commonly discussed ideas, but I really have no sense for the probability or timing of any of them coming to fruition. And as you hear me think out loud about these ideas, please trust me that I'm doing so without any political agenda.

7:18Instead, picture us sitting together in a client meeting, because this is probably how I would frame up possible changes that could impact your financial plan. Let's start with the proposal that seems to get the most airtime, at least from my perspective. and that's means testing social security, which would reduce or eliminate benefits for people with higher income or net worths. I've always thought this seems somewhat sensible, but I do sometimes wonder if changes like this could undermine the long-term support for the program because people might then begin viewing social security as a welfare program rather than a universal entitlement program that it is today.

7:59And there is a huge difference between welfare and entitlement, but I'm going to set that tangent on the side for now. However, I can't see how politicians might like all the nuances and measurements involved with mean testings, because that gives them lots of things to debate and negotiate, and we've got to give the politicians something to argue about, right? In all seriousness, another idea that gets quite a bit of airtime is just changing the full retirement age for collecting full social security benefits. Not only does this reduce the amount of benefits a retiree receives over their lifetime, but it could also theoretically increase the number of years somebody works and continues paying FICA taxes.

8:41You could also point to the fact that people are living much longer than once before. However, there is also pretty concrete data showing that life expectancy is closely tied to income. I'm not saying that makes increasing the full retirement age right or wrong, but I do think it's worth noting as we begin to handicap different possibilities for future changes to Social Security. Increasing taxes, now that is always an option that is discussed. In 2024, earnings above$168 ,600 are exempt from Social Security's 6.2 % payroll tax. Increasing that threshold would provide a relatively hassle-free way to increase tax revenues earmarked for Social Security benefits.

9:29It's hard to picture this type of thing happening anytime Republicans control Congress, but this is a change I'd expect to see at some point in time over longer horizons. And lastly, another lever to be pulled would be creating stricter disability benefits. And I feel like the criteria is already pretty strict, so I'm not entirely sure what the trade-off between stringency and savings to the program would really be. But I honestly don't let this idea distract me too much with clients because I prefer that they rely on private disability policies in their working years while being fully self-insured for disability in retirement.

10:10With everything we've discussed today, it's time now to address the big question, and that is, how should you incorporate Social Security into your financial plan? I think different parts of planning require different assumptions about Social Security, and how aggressive you are with those assumptions really would come down to what sort of probabilities and timelines you assign to some of those suggestions I just laid out. Now, in my opinion, a place you should always include Social Security is in tax projections, particularly as it pertains to decisions around Roth conversions and large charitable donations.

10:49In my opinion, excluding Social Security income in any evaluation of the trade-offs between paying taxes today versus in the future would be very, very aggressive. Now, when you're performing Monte Carlo simulations to test how changing market conditions or other variables would affect your ability to meet your goals, I actually think it's best to exclude receiving Social Security. If you aren't familiar with the Monte Carlo analysis, it's when you run assumptions about all your future inflows and outflows through a series of randomized return streams that uses another set of assumptions regarding the returns, volatility, and correlation of different investments.

11:31Yes, you heard me correctly. That's two entirely different sets of assumptions mentioned in a single sentence describing a Monte Carlo simulation. I think everybody who has gone through one of these before knows that a Monte Carlo isn't supposed to be a crystal ball, but rather act as a framework for making decisions about things in life, such as your asset allocation, when to retire, how much you can afford to spend, that sort of thing. But by assuming you'll receive no social security payments in your base case scenario, you create a lot more conservative of a framework from which to make decisions.

12:07Now, even though I feel fairly confident that everyone will receive some form of social security payments, I feel really strongly that this is the best way to run a base case. And that's the great thing about Monte Carlo's is that you can run lots of iterations off that base case. For example, I've come across a number of people in their 50s who are thinking about retiring before the age of 60 or maybe in their early 60s. And so the base case might give them a little bit of confidence, but not necessarily all the confidence they need to pull the trigger on an early retirement. But when you add back in Social Security, it ends up boosting the results and often gives people the necessary confidence they need to retire early.

12:51And I personally think it's very, very reasonable for people in their 50s to expect some form of Social Security payments. Now, the other thing that Social Security is going to impact in your Monte Carlo analysis, whether you include it or not, might be your asset allocation. But honestly, I don't think it would be that material. I don't think you're going to own more stocks or more bonds simply based on whether or not Social Security payments are coming to your bank account. I also don't really think in your portfolio there's a material one-to-one impact from the current solvency of social security trust accounts or potential changes to the social security program that could allow you to implement a trade of sorts.

13:36As I discussed last episode when we dove a little deeper into modern monetary theory, inflation is a risk of overspending. And typically in your portfolio, stocks are going to be the best long-term hedge against inflation. Unexpected bouts of inflation, it's really something that would require the type of hedging trade as opposed to long-term investment to really offset it. And the timing would have to be right. Otherwise, you would be sitting there with a losing position more often than you'd be sitting there with a winning position. and any sort of timing trade is obviously going to be very difficult.

14:16I hope today's episode, along with some of the past prior ones, have helped giving you some sort of clarity on today's monetary system, on fiscal policy. And if you're enjoying these episodes, I would greatly appreciate if you took the time to leave a review on Apple Podcasts or Spotify Podcasts. As always, you can find links and resources to everything mentioned in the show notes at thelongterminvestor.com. Thanks for listening. And until next time to Long-Term Investing.

15:07solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.