Social Security benefits are already eroding

Second of two parts

Will Social Security be there when it's time for you to retire? Last week, we looked at the possible Social Security reforms coming down the track.

Social Security was revamped in 1983 to avert a financial crisis, and in anticipation of the boomer retirement wave. The most important change was a gradual increase in the age when seniors could file for full benefits -- the so-called Normal Retirement Age.

The reform package set in motion a gradual increase in the Normal Retirement Age, from 65 to 67 for people reaching that age in 2022. At that point, monthly benefits will be about 13 percent smaller than they would be had the retirement age stayed at 65, according to the National Academy of Social Insurance.

Since benefits are reduced if you file before the Normal Retirement Age and increased if you file later, here's an example of what happens when the NRA rises. If you were born between 1943 and 1954, your full retirement age is 66. "If you decided to take benefits early, at 65, you would no longer get a full benefit, but a fraction of a full benefit," explains Virginia Reno, NASI's vice president for income security. "On the other hand, by waiting until 66, you used to get more than a full benefit when the full retirement age was 65 -- now you don't."

The higher retirement age, therefore, is an across-the-board cut in your monthly benefit check -- no matter at what age you retire.

The 1983 reforms also added new taxes on Social Security benefits and a small delay in cost-of-living adjustments; all told, the package cut amounts to a phased-in benefit cut of 20 percent, according to the National Academy of Social Insurance.

Rising Medicare premiums also are eating away at Social Security's value. Medicare Part B (outpatient services) usually is deducted from monthly Social Security payments. With health-care costs soaring, those premiums are projected to jump from 6 percent of benefits for someone retiring as recently as 2003 to 9 percent for someone retiring in 2030, according to the Center for Retirement Research at Boston College.

The net effect: Social Security will replace a smaller share of pre-retirement income over time. The Center for Retirement Research has compared replacement rates for an average earner who retires at age 65 in 2002 and 2030; its forecast shows that replacement rates will fall from 41 percent to just 29 percent.

How can you combat Social Security's shrinking value? In most cases, by taking your time filing for benefits. Monthly benefit payments are 8 percent higher for every year you wait, up until age 70. That can really add up over time; if you wait until age 70 to claim benefits, your monthly income will be about 76 percent higher than it would be if you had claimed benefits at age 62.

Many workers worry that they'll clip their lifetime payouts by waiting. But Social Security's most important function is to protect you from longevity risk -- that is, the risk of running out of money in advanced age, when work probably isn't an option, pensions may be eroded by inflation, and savings may be depleted.

"Your lifetime benefits depend on how long you live -- but no one can know that," says Virginia Reno, National Academy of Social Insurance's vice president for income security. "The right question is, 'How do I protect myself against reaching age 95 with no savings left and an inadequate Social Security benefit?' "

And for married couples, if the higher earner is the man, it's especially important for him to wait to file as long as possible. Women usually outlive men; Social Security's survivor benefit allows a widowed spouse to receive 100 percent of her husband's benefits.

Should you discount Social Security's future value in your retirement plan? It depends on your age.

Current retirees and workers within 10 years of their National Retirement Age can count on receiving 100 percent of their benefits, since the Social Security Administration's current projections include all the adjustments from the 1983 reforms. And no one proposing more changes to the system advocates changing benefits for today's seniors or those near retirement.

Many financial planners advocate a conservative approach for younger workers. Since Social Security currently can promise to pay only 78 percent of benefits past 2035, many discount future benefits on the assumption that no solutions will be reached in Washington.

"If the majority of a client's retirement years are projected to be after that date, I use that information," says William Duncan, a Nevada financial planner.

Laura Scharr of Ascend Financial Planning in Columbia, S.C., discounts projected client benefits based on different age brackets. "For clients over 60, I assume 100 percent of benefits, but only a 1 percent COLA, vs. my overall 4 percent inflation assumption," she says. For clients over age 50, she plans for only 75 percent of benefits being available, and 50 percent for those over 40. "If a client is under age 40, I assume nothing unless they're in a lower socio-economic bracket."

But even affluent clients need to consider longevity risk, says Mark Balasa of Balasa, Dinverno Foltz, a private wealth management firm serving high net worth clients. "Even some of our clients with $1 million or more of investable assets can use up those funds because of their spending habits," he says. "So if you run a plan for them without Social Security, they don't have enough to make it to their life expectancy."

Mark Miller's Retire Smart column is carried on Tribune Media Services.