Should Social Security Benefits be Capped? by Scott Stolz, CFP, RICP (week 46)

 

We continue to get closer to the date at which the Social Security Trust Fund will be depleted.  Yet Congress continues to do nothing to solve this problem.  Under current law, once the trust fund is depleted in 2034, benefits must be cut across the board.  This cut is expected to be 24%.  I covered potential solutions as well as made my prediction of how Congress will most likely deal with this problem in an earlier blog (How They Will Likely Fix Social Security by Scott Stolz, CFP, RICP (week 29).  A column in this week’s Barron’s offered a new potential solution which I expect will get legs because it will initially impact few taxpayers.  In fact, the title of the article is “Social Security is Broken.  Benefit Cuts for the Rich Are the Fix.” (Social Security Is Broken. Benefit Cuts for the Rich Are the Fix. - Barron's).  Who doesn’t like the idea of a problem like this being solved by taxing those that have more money than they need? 

The suggested solution is to cap all Social Security benefits to $100,000 per year for a couple and $50,000 per year for any individual.  As the author stated, “Paying six-figure benefits to some of the world’s wealthiest couples is indefensible, given Social Security’s dire fiscal straits.”  This solution is likely to appeal to the person that is receiving a benefit in line with the current average of $2,000 per month.  That person won’t be impacted at all.  In fact, this change would initially impact less than 1% of all Social Security recipients.  The fact of the matter is that very few people have earned enough every year throughout their entire working life to get a benefit anywhere near these caps.

Of course, this also means that this solution won’t go very far to solve Social Securities’ issues – at least initially.  Over time however, if the $50,000/$100,000 cap is not indexed for inflation, more and more recipients will begin to hit the cap.  Therefore, this would be a very subtle way to slowly and quietly reduce benefits for an increasing number of people.  And now that this solution has been thrown into the mix, it’s just a matter of time until someone suggests lower caps would make more sense.  If only 10% of recipients currently receive more than $3,000 per month in benefits, perhaps that’s really the place to start?  After all, those individuals made a lot of money over their lifetime as well, and most of them could probably afford the benefit cut.  It doesn’t take a genius to see where this is heading.

This is where I feel a need to remind everyone that Social Security benefits are a reflection of how much each taxpayer pays in Social Security taxes throughout his or her working life – both directly and  by his or her employer.  The more you make, the more you pay in taxes, the more you get in benefits.  However, the system is designed so that there is not a direct correlation between how much you pay in and how much you get back.  It’s actually designed so that high earners subsidize lower earners.  As you make more and pay more taxes into the system, the amount you get back relative to your contributions drops.  Someone that has made $50,000 per year over their lifetime, will get an annual Social Security benefit of about $24,170 or almost 50% of their annual income.  Contrast that to the person that would be close to the capped benefit amounts suggested by the author in the Barron’s article.  That person will get a benefit of about $49,000 per year, or roughly 28% of the income on which they were taxed.  Yes, they will get about twice as much money each year, but they also paid in 3.5 times as much in taxes.

It's obvious to me that when Congress finally gets around to fixing Social Security, they will do so by a combination of raising taxes and cutting benefits.  Most of the new taxes will come from raising the current cap of $184,500 on which Social Security taxes are paid.  And now we see the game plan for assessing the benefit cuts mostly on those that receive the highest benefits.  As I stated in my previous blog, I’m OK with this general approach.  Too many rely on Social Security for a significant amount of their income.  No one benefits by creating a huge financial hardship to a large percentage of current and future retirees.  I just hope that Congress is upfront about what they are doing.  They should acknowledge that they need the wealthier individuals to further subsidize others and therefore they are asking them to step up.  Don’t spin it by implying that the rich have been getting away with paying less and/or getting more.  But I suspect I won’t get my wish on this one.  Spinning it will just politically expedient when Congress must go back to their district and face the voters.