Congress’ inaction on Social Security could cost clients 2 months’ pay

Not knowing about what will happen to the Social Security system when its trust fund would be depleted around 2035 has financial consequences for people saving for retirement.

The cost is, on average, more than two months of earnings, according to a recent academic paper published by the National Bureau of Economic Research.

The figure isn’t tied to the actual financial consequences of the Social Security system becoming insolvent. Rather, it’s a cost that researchers said stems from not knowing how to plan, given the uncertainty around how Congress will adjust the system to ensure its long-term viability.

“This indecision leaves young and middle-aged workers not knowing whether they will face Social Security benefit cuts, payroll tax increases or an increase in the full retirement age,” the authors wrote. “We find that the cost of indecision can be large. In some cases, the value of knowing today what the policy change will be in 2035 is worth more than two months of labor market earnings.”

The federal government could help people avoid planning mistakes by moving as quickly as possible to address Social Security’s future, they noted.

Changes to Social Security will affect retirement income in almost all instances. For example, a simulation shows that an increase in the full retirement age to 70 would cost a woman born in 1970, with average earnings, about $124,000, while it would be nearly $148,000 for a woman born in 1990, the report found.

But because people can plan for changes they know will occur, the negative effects due to indecision by Congress can be avoided, the authors stated.

Having 15 years to plan for a 20% cut in benefits is worth about $9,000 for an average-earning woman born in 1975, or about 1.5 months of pay, they calculated.

“If the value of advance knowledge is measured relative to earnings, then the stakes are actually higher for low-income workers than high-income workers,” the paper read. “Low earners rely more on Social Security, so it comes as no surprise that advance information about future policies would be proportionately more valuable to lower-income individuals.”

The two types of mistakes people could make in retirement planning are either assuming that Social Security benefits will remain constant even after the trust’s exhaustion, or that they will face benefits cuts that end up not happening, according to the report. Both types of planning mistakes can be equally costly for people trying to save for retirement, the authors noted.

By 2035, revenue from Social Security will be able to pay about 79% of promised benefits, according to the most recent report from the agency.

“Policymakers are well aware that the trust fund will be exhausted in the early 2030s, and the policy options that will be available at that time are known now,” the paper stated. “[S]imply deciding now what policy will be followed when the trust fund runs dry, rather than waiting until 2035, can be the equivalent of giving people a bonus of between one and two and a half months of earnings.”

The authors of the paper, “How does Social Security reform indecision affect younger cohorts?” are John Shoven, professor emeritus at Stanford University; Sita Slavov, director of the public policy doctorate program at George Mason University; and John Watson, a lecturer in finance at the Stanford Graduate School of Business.

The post Congress’ inaction on Social Security could cost clients 2 months’ pay appeared first on InvestmentNews.

As our second lead editor, Cindy Hamilton covers health, fitness and other wellness topics. She is also instrumental in making sure the content on the site is clear and accurate for our readers. Cindy received a BA and an MA from NYU.

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