Navigating the Retirement Risk Zone

In today's episode
of Navigating the Retirement Risk Zone,

we're going to talk about Social Security
and its place in retirement planning.

A recent comment left

by one viewer on the channel said
something like, I think you can not retire

with too much money, but
you can never retire with too much money.

In other words, you can keep working
when you should retire.

But when you retire,
there is never too much money.

And that does feel fairly appropriate,
especially when it comes to thinking

about Social Security.

What I found

is that no matter how much money you have,
no matter how wealthy you are,

no one thinks that Social Security
is unimportant.

We're still really interested in
optimizing our Social Security decision,

even if it actually has very little
to no impact on our retirement finances.

So in today's video,
I'd like to go into four key components

of Social Security
and its place in retirement planning.

We’re going to talk about the basics
of how Social Security works.

We're going to talk
through the claiming decision.

What are the factors
you should evaluate when you're trying

to make the best claiming decision
for you and your situation?

We'll talk through Social Security
as an investment.

What makes it unique?

And then we'll also
talk about the long term

viability of Social Security
and how you should plan for that.

If you'd like to skip
through the different components here,

we’ll leave some chapters
and any of the resources I talk about in

this video, we’ll leave in the details
or the comment section

below or the notes below the podcast
if you're listening to just audio.

This will actually be my first attempt
at an audio only video.

It'll have video accompanying with it,
but none of the graphics or visuals

that I'm looking at
will I show on the screen.

So you'll want to check the show notes

for any of those things,
but let's just jump right into it.

So the question at hand
first is how does Social Security work?

When you want to make
the optimal Social Security

claiming decision,
as with anything in your life,

you need to understand how it works.

And the basics
are you paying the Social Security,

Social Security system factors in your 35
most recent years of earnings

and uses that to calculate
a primary insurance amount

or an estimate of a dollar amount based
on which a bunch of formulas can be run

that determine

what your actual Social Security
monthly benefit that will be paid out is.

Then from there, the formula actually
is determined based off of a specific age.

67 right now in the U.S.

is what's called full retirement age.

That full retirement age changes
slightly based on the year you were born.

But for most people who’d
be retiring after watching

this video, you will likely be
at full retirement age at 67.

Now, if you'd like to find out

what exact month, sometimes it's somewhere
between 66 and 6 months or so

all the way up to 67
would constitute your full retirement age.

Then you can go and look on the Social
Security Administration website.

We can include a link to that below.

But the basic idea is
your full retirement age

is the age at which you're pegged

to receive the full amount
of your Social Security benefit.

And then a formula is run
that reduces the benefit for every month

that you retire earlier than full
retirement age by a certain amount.

And then it increases the benefit
if you delay retirement

or delay let’s say not retirement,

delay claiming Social Security for each month

after age 67 or full retirement age.

It's very important
to understand this concept

because if you download
a Social Security statement,

you'll see a whole bunch

of different projections
or predictions of how much money

you'd get per month
based on the age you retire at.

And when you do your calculations,
you should make sure that you're pegging

your original Social Security amount

or your base
amount to your full retirement age.

And then financial planning tools,
if you're using them,

will also peg based off of that.

And there can be a lot of miscommunication
or misunderstanding around

what your reduced or increased
benefit will be.

So start by using your
full retirement age

and understanding
that it works off of that.

If you were to claim as early as 62,
which is the earliest age anyone can claim

Social Security, you would receive roughly
32% reduced benefit.

And then if you were to claim by age 62,
which is the earliest possible age

at which you could claim you would receive
a roughly 30% reduction in benefit,

and then every month
between you would increase your benefit

by a small amount
all the way up to your full benefit at 67.

And if you were to claim at 70,
which is the latest possible

claiming age, would receive
an increased benefit of 32%.

Just gives you an idea.

So you could take that full retirement age
number.

Say if I claim it 70,
it would be plus 32%.

So on and so forth.

But this just gives you an idea

of how to understand the exact way
to calculate your Social Security benefit.

The final point here about how
Social Security works is how it's taxed.

And yes, Social Security is taxed, Right?

You should understand that.

There is a formula that determines

how much of your Social Security income
is considered taxable income.

You'll want to reference
the Social Security Administration

website for the exact formula.

But roughly speaking,
there's a threshold below which,

if your income is below
a certain dollar amount,

like, your total annual income,
not just Social Security,

but from all sources,
if it's below a certain dollar amount,

you're taxed on nothing.

If it's between threshold
two and three.

So it's above a certain dollar amount,
but below a certain dollar amount,

then you're going to be taxed on up
to 50% of the benefit.

And then if you hit
that third threshold,

then you're taxed on 85%
of your Social Security benefits.

Right? So you have to factor
in all your other sources of income.

And you may not only have
Social Security income,

you may also still be working
or have portfolio

income or rental property
income or something.

And that will determine

how much of your Social Security income
is considered taxable income,

and therefore how much is taxed

and how it will affect
your other income being taxed.

You should use

the assistance
of a financial planning tool

or even a financial planner

if you want to really get
a clear picture of those numbers.

But just understand
Social Security is taxed.

This leads us to the second topic here,
which is understanding Social Security

as an investment.

There's really two key features
that make Social Security very unique.

The first is that Social Security income
gets a cost of living adjustment

each year.

That is based on the rate of inflation.

And this is very, very unique
because Social Security

really can best be thought
of as an annuity or a pension.

It's essentially a guaranteed stream
of income payments.

That you are not responsible
for the underlying investments.

That means you need as the person
who gets the Social Security benefit,

you have no responsibility
for understanding

what investments must be made,
how you craft the income, whether it is

even appropriate or responsible
to get that amount of income out

of what you've paid in.

You completely delegate
all those responsibilities,

you need take no responsibility and so
you get that guaranteed source of income.

On top of that,

you get a cost of living adjustment
that is pegged to inflation.

And that is very, very uncommon
in most annuity or pension world

And most annuities you’d have
to pay for some kind of a rider

that would be pretty expensive
and would limit

the cost of living increase
you would get each year.

But for Social Security,
you don't have to pay anything extra.

You just get this cost of living
adjustment.

It's a very, very powerful tool
because one of those things in retirement

is that you are not in control
of the rate of inflation whatsoever.

So it makes it very difficult
to plan for that.

And because Social Security
gets this guaranteed

cost of living adjustment,
it's a great sense of relief

and a very powerful investment
that would be very hard to replicate.

Where you to, let's say, get paid
out a lump sum that was exactly equal

to what your Social Security payment lump
sum payment would be.

And then still craft
that income in your own,

it would be much, much more difficult,
maybe impossible do that.

So this is a huge, huge benefit
that can’t get overlooked.

Which leads into the third
part of this explanation,

which is once you understand

that it is an annuity
and you're not responsible

for the investment income
and you get the cost of living

and you understand how Social Security

program works, roughly
how this spectrum of early claiming versus

full retirement age
versus late claiming works,

the question comes into play of

how do you actually evaluate the
factors that are important in your own

personal claiming decision?

There's really four key factors.

There's probably more if you really wanted
to dive deeper into it.

But the primary four are the following.

What is your actual sources
of guaranteed income

in addition to Social Security?

That's a huge driving factor because
you may have other sources of guaranteed

income like pensions, annuities
that support all of your personal

spending desires in retirement,

which makes Social
Security supplemental.

You know, it's a bonus.

And that might make it a no brainer
to defer claiming till 70

because you don't need the income
in your early retirement years.

Now, if that's not the case,
you'll have to make other decisions.

But that's why it's very important
to first start by understanding what

your other sources of guaranteed income
would be, what ages those would start.

And then just writing that down.

The second thing you need to understand
is how much do you want

to spend in retirement
and when would you actually retire? Right?

So let's say you wanted to retire at 65
and you want to spend $10,000

per month at age
65 going forward, adjusted for inflation.

Well, you'd have to ask that...
You'd have to write this down.

I retire at 65.

I want $10,000 per month.

My other guaranteed
sources of income cover,

let's say $7,500 per month.

I would be responsible for finding this
other $2,500 that's missing.

And the question is, is it better to take
that out of my retirement portfolio,

you know, saved moneys,
or is it better to claim Social Security

and get that money through Social Security
and not touch my retirement portfolio?

The point being that
when you're evaluating this, you're

really evaluating an opportunity cost
between two different options.

You're trying to decide,
do I preserve my retirement portfolio

and use social Security to
get me through some gap years?

Or do I take Social Security sorry,
or do I start drawing from my portfolio

and defer Social Security?
And there are reasons to consider both.

But you can't really truly evaluate those

until you understand

how much you want to spend,
what your other guaranteed

sources of income are,
and what the consequence

is of taking money out of your portfolio
would be or deferring Social Security.

Right?

You have to understand that

and the only way to understand
that is through a cash flow lens

where you understand
how much you'd like to spend

and what the impact or sustainability
impact would have on your portfolio.

The next step here would be to understand
spouses how it affects the spouse

if you're married?

Spouses get us a benefit based on the
higher earning record of their spouse.

And there's also what's
called a survivor benefit,

which the surviving spouse,
if the one partner were to be deceased

and the surviving spouse
were to live on,

the surviving spouse’s benefit is pegged
to the amount of Social Security

that the benefit
that their deceased spouse

get would have gotten based on
when they claim.

And so if you claim early as the higher
earner, let's say you're husband and wife,

the husband retires at age 62, claims
Social Security at age 62 and gets this

30% reduced benefit.

And let's say they were
the higher earner,

so they would have gotten the larger
pool of Social Security funds anyways.

Well, let's say they now pass away at 65
and the wife would get spousal benefits

or surviving spouse benefits
against their deceased husband's record.

That surviving
spouse gets a reduced benefit.

It's based off of
when their husband had claimed

and since the husband claimed
reduced benefits at age 62,

the surviving spouse
now also gets reduced benefits.

And so understanding
that is a really important factor

that determines
how you might want to claim,

because you may have a portfolio

that can't support, you know, assumed
how much you might assume you'll live.

And if the

if the higher earner claims too early,
the surviving spouse gets a reduced benefit

and it places more strain on the portfolio

because now
they're getting a reduced benefit

and the portfolio is now responsible
for a larger proportion

of that household's income,
you got to think about that.

And then the fourth and final part here
that we factor into the claiming decision

is a risk,

we call it like a risk factor.

Because essentially what you're trying to

decide is do I claim at full retirement age
and get my stated benefit?

Do I claim at age 62 and get a reduced benefit
but start getting an income stream earlier.

When you claim at 62
or earlier than full retirement age,

what you're really trying...

The calculus you’re really
making is I need this income

payment in order to sustain my portfolio
because if I start drawing on my portfolio

when I'm younger, I may live too long
and run out of money while still alive,

or my distribution rate

from my portfolio may be too high
in my early years of retirement

while I'm young and I need a
supplemental source of income to kind of,

you know, conserve
or may help my portfolio survive.

And so I'm claiming earlier
because in some way that helps me

elongate or lengthen the
life span of my portfolio.

And when you claim at 70,
what you're effectively saying is

I have enough retirement assets saved

or enough other sources of income
that I don’t need the Social Security,

and so therefore I can delay it,
use other sources of funds,

and then get the increased benefit

that also gets the increased compounding
of the cost of living adjustment.

When you think of that way,
what you're really doing is

you're either pushing back
risk when you claim younger

or, you know, when you
claim at reduced benefits,

you're pushing risk into the back
end of your retirement

because what you're doing is you're taking
an income stream earlier to reduce

the distribution rate of your portfolio
or reduce the tax on your portfolio.

But what's going to happen is later
in your retirement, because of inflation,

your portfolio’s distribution
rate will go up and up and up over time.

And when you enter,
when you get to the final years

of your retirement,
where your costs are the highest,

you’re going to have the lowest
Social Security benefit

and therefore need the most
from your portfolio.

And it presents what we
call backloaded risk.

Your risk is in the back
end of your retirement

when you claim early
for Social Security

And vice versa,
when you defer Social Security

and you retire before claiming let's say
you retire at 65 but you defer claiming

till 70, you have a five
year frontloaded risk

because you don't have
that extra income stream.

And so you have to take more out of saved
assets and you're going to take that risk

and bring it
to the front of your retirement,

because having that larger Social Security
benefit gives you kind of insurance.

It gives you longevity insurance.

Longevity insurance meaning

if you live longer than expected,
you have a higher Social Security benefit

and therefore it kind of insures your back
end of your retirement.

It's a helpful way to think
about it through that lens.

And it can help influence
your claiming decision.

And as you can see here,
it's kind of a complicated puzzle

of putting these different things
together.

Your guaranteed sources of income,

how much you want to spend,

when you'll retire,

are you going to claim at the same age
as retirement, defer or claim early?

What's the distribution rate
on your portfolio?

Synthesizing all that information.

But it's very, very important
because Social Security actually

has a huge impact on people's
sustainability in retirement.

Making the right decision when claiming
Social Security has a huge impact.

And this leads us to...

It probably opens the door to
more questions than answers.

But those are the basic details.

And this leads us
to the final point of this podcast,

which is what about the long term
viability of Social Security?

And how do I plan for that?

You know,
it might feel natural to just say,

screw it, I'm just going to
claim Social Security at 62

because I have no idea
if the program will be around.

I've paid in. I want to get the most
that I can out of it.

So, you know, I'm
just going and diving in as early as I can

and that is really not a very good way
to look at it.

Let's talk about how the viability
of Social Security actually is affected.

So these are... I'm reading
some quotes off the screen here

that come directly from the Center
for Retirement Research in 2024.

So according to a recent update

from the Center for
Retirement Research,

the depletion of the
Social Security Trust fund

does not mean that the fund is bankrupt.

Payroll tax revenues each year keep coming
in and cover 77% of annual benefits,

which will decline to 71% of annual
benefits by the end of the projection

that this research center did.

It continues,

Social Security's long run
deficit is projected to equal

3.61% of covered payroll earnings.

That figure means that
if payroll taxes were raised today

by 3.61%, 1.8% for the employers
and 1.8% for employees,

the government can pay benefits as they're
currently stated through 2097 and

have a reserve at the end of that period,
which would be kind of revolutionary.

There is no reserve.

So this actually indicates that
if payroll taxes were increased by 3.61%,

we'd actually have a surplus
in the Social Security trust

fund at the end of this roughly 70 year
period that they're talking about.

And so the question here is like
how bankrupt is the fund?

And the answer is
it's not really exactly totally bankrupt.

Payroll taxes actually support 70
plus percent of the annual benefit amount.

There is a gap of roughly 23 to 30%
depending on what year we're

talking about.

That does have to be filled
by other sources, and that is a problem.

But the program
doesn't just go away.

Now, as things currently stand,

if there are no changes to the program,
that would increase the viability

or kind of fix that 25
to 30% gap,

in early 2030, 2032, Social Security
benefits are pegged to go down.

I think that's personally probably
very unlikely to happen

because Social Security politically
is such a hot button issue

and it would be a death sentence
pretty much to

whichever political party was in power
at the time that went into effect.

So I think that it's likely
there will be some changes

that are put into play
before that happens.

So between now and then, who knows?

I don't have a crystal ball.

But there are a couple likely changes
to Social Security that actually are kind

of might feel minimal to you or I,
but actually have a huge impact

on the long term
sustainability of Social Security.

And I'll go through a few of them
right here.

So there's really three options
that have a big impact

that don't just completely devastate
the program.

The first is if cost of living adjustments
annually reduced by

1% per year, that would solve
half of the Social Security shortfall.

So what does that actually mean?

Let's say that the cost of living
adjustment for 2024 is going to be 4%

because that's
the rate of inflation in 2024.

This is determined
the end of the ensuing year.

Let this proposed solution would say,
well, even if inflation is 4%,

we're only going to increase the cost
of living adjustment by 3%.

And if in 2025 the cost of living
adjustment is 2.7%, our inflation is 2.7%,

the cost of living
adjustment would be 1.7%.

So this means you'd get a 1% reduction
in the cost of living adjustment

going forward.

Just to remember,

most pensions and annuities don't come
with the cost of living adjustment.

This is a huge, huge benefit that is a
part of the Social Security program.

Yes, people
would feel it in a small amount,

but it's probably a lot more palatable
to have a 1% reduction

in cost of living adjustment each year
than to be someone like myself

who's 35 paid into Social Security
until I'm 65, but end up only getting 50%

of the benefits that I might have
gotten were I to retire in 2024.

Right.

So this is a, let's say,
a finessed solution.

It does cover half of
the Social Security shortfall.

There's a second option here, which
would be increasing the retirement age.

So people live a lot longer now.

And that's been part of the problem

for the Social Security system.

You could potentially
increase the retirement age

from the full retirement age,

FRA, which is the age
at which you get full benefits,

from 67 to 70 and this has been proposed
and there's research of some done off of this.

The proposal is to increase the
retirement age or full retirement age

from 67 to 70 in a slow roll
out over a period of 12 years.

And this would also solve
half of the Social Security shortfall.

So you could combine both of these things
and solve the shortfall altogether

without actually reducing
anyone's benefits,

which is the current plan.

And then the third and final proposal
is to just reduce benefits,

which is already the plan that would go
into effect, probably the least palatable

and least likely of the options because
it's going to be so politically unpopular.

Again, this is all speculation,
but I hope what this explanation

does is put into perspective how damned
Social Security program is, like

it has a problem,
but it is not fully dammed.

And if we think of it as a binary meaning,
it’s all there or not there,

it can lead us to making
really bad claiming decisions

when this is such an influential tool
in most people's retirement plan success.

And you know many people,

it might be a curiosity

at what level of wealth is
Social Security

not really influential
in my spending behaviors,

which means it's a complete luxury
decision to claim earlier, claim late.

And the answer is there's probably
a threshold of level of wealth.

But in the people with the people
I've spoken to,

doesn't matter how wealthy you are
and you still they still report

wanting to make a quote unquote
optimal Social Security claiming decision.

And so I'd kind of throw
that binary thought out the door

and just go with the fact
that you should understand

everything we've talked
about in this podcast.

You should really consider
and think it through.

What is your unique personal puzzle?

How do you make the best Social Security
claiming decision for you?

And understand what the future holds
may hold for Social Security

so you can make good decisions
and not an impulsive one

because you think it's just going to get

get thrown in the garbage
and you're going to get nothing out of it

if you don't claim as early
as possible or whatever.

So, I hope you found this helpful.

Now, my first attempt at audio only,
and like I said, all the resources

I mentioned and all the
the statistics and proposals,

I’ll include them in the show notes

on both YouTube and
in the podcast section.

Thanks for listening and I'd appreciate
any feedback you have about how this went

or any questions you may have
that you'd like me to do a podcast,

I'll audio only explanation of.

Could be about your own particular situation.

Don't be shy.

Send me anything you'd like
and I'll do my best

to make it over time and publish it.

Thanks again for your time and attention

and see you in the next
video and the next podcast.