Waffles and Chicken(shit)

I’ve waffled in recent weeks on the need to write a post about Social Security for the Pension Series. On the one hand, since the American form of Social Security pays out in annuity form, it seems like a relevant topic for the Series. Plus, an overwhelming majority of American workers pay into the program. Therefore, it’s the sole remaining Defined Benefit Plan (DBP) that almost all Americans workers still have access to in retirement. Finally, because almost everyone’s eligible for Social Security in America, there’s uncertainty surrounding the future financial viability of the program. That uncertainty alone is enough to justify the need for an article since much of the Pension Series is built around the idea of quantifying the uncertainty surrounding pensions.

On the other hand, there are a lot of drawbacks to writing an article on Social Security. First and foremost, is the sheer number of articles already written about the subject. From books to news articles, to blogs, and podcasts; I doubt there’s a format of media that hasn’t been utilized to discuss Social Security in the USA. That’s partly due to the fact that Social Security is an extremely controversial topic. Since nearly everyone’s entitled to it, nearly everyone has a strong opinion about it. In fact, the government calls it an entitlement, and as an entitlement, it’s earned a reputation as a third rail in American politics — meaning a politician touches it at their own peril much like the electrified third rail in a subway system.

“That Tears It”

Although many issues surrounding public pensions are inherently political, I tend to avoid tackling issues that I know are straight-up political topics. Call me chickenshit if you like, but I got enough drama in my life without courting internet trolls. That said, the factor that convinced me to get off the fence was a recent two-part podcast from Optimal Finance Daily (OFD). For those unfamiliar with OFD, it’s a podcast where they read blog posts curated from a list of the best personal finance and Financial Independence (FI) bloggers. I’ve blogged about it before. How’s that for meta? Blogging about a podcast that read blog posts. Unfortunately, not my own though!

This case was no different. The OFD narrator was reading JL Collin’s article on the future of Social Security. That article was originally published in 2013, but JL’s kept it updated. For the record, I’m a huge JL Collins fan. If he’s got a bandwagon, I’m not only on it, but I’ll get out and push if need be. His book, “A Simple Path to Wealth“, is on my must-read list. However, I don’t always agree with everything he writes or says. In the case of his Social Security article, I was picking up everything the OFD narrator was laying down … until the conclusion. That’s when I heard this part:

Recommendation: Plan your financial future assuming Social Security will NOT be there for you. Live below your means, invest the surplus, avoid debt and accumulate F-You Money. Be independent, financially and otherwise. If/when Social Security comes thru, enjoy.

No, NO, NO! Dammit JL, if ever there was a recipe for forcing people to work longer, you just cooked it up. That tore it, an article on Social Security I would write.

The Issue

To be clear, my issue with JL Collins’ article has nothing to do with the facts he uses. As far as I can tell, his article is well researched. In case you need a second opinion, try this article from Jill Schlesinger’s Jill on Money blog. Even with two-year-old numbers, it still looks accurate. Anyone who needs a primer on the issue of Social Security should read both of these articles, and then move onto the aforementioned books, blogs, and podcasts dedicated to this topic.

My only issue with JL Collins’ article is his conclusion. Stating that one should plan their financial future as if Social Security won’t exist, is, in my humble opinion, overly cautionary. It’s the same type of erroneous advice I see passed around the internet and Facebook in connection to pensions. Without fail, whenever someone asks how they should incorporate their pension into their retirement planning (or their Financial Independence calculations), someone else will advise the questioner to plan as if the pension won’t be there.

What Have We Learned Class?

If we’ve learned nothing else from the Pension Series, it’s that the story surrounding pension safety is highly dependent on the individual pension fund. Thus, drawing large-scale pension safety assumptions and applying them to an individual’s circumstances is almost a worthless exercise. Not only that, but persuading someone to ignore the likelihood that some, or all, of their pension, will be there in retirement, dooms them to work longer than they otherwise might need in an effort to accumulate more of their own savings.

I don’t know about you, but I’m looking to retire as early as possible based on accurate probabilities that some or all of my pension will be there for me in retirement. The same goes for my social security. I’m not looking to work longer to meet some overly prudent judgment that ignores the probabilities. I say that as a financially conservative guy as well. I’m not a risk taker when it comes to money. At the same time, I’m not willing to doom myself to more work years at a job I’m gutting out, in order to accumulate a larger nest egg than what I need. If my conservative math tells me something different, I’m going with that.

Counter-Argument (Part1)

It’s my belief that JL Collins (and many others) advise people to plan as if their Social Security or pension won’t be there in retirement because they’re biased. For many Financial Independence writers, reliance on assistance from the government or a pension fund to enable a successful retirement is anathema to the entire concept of Financial Independence. In other words, can you be truly FI if you rely on a pension or Social Security check each month?

If you believe the answer to that question is “no”, then it assumes that what a pension fund or government grants, it can also take away. In those people’s mind, it probably seems prudent to plan as if Social Security or a pension won’t be there, because you never know what will happen. Thus, the only money you can rely on in retirement is the money you’ve saved and invested yourself.

Counter-Argument (Part 2)

I can understand this type of sentiment up to a point. There’s plenty of historical evidence to support the worst case scenario. The list of failed American pension funds is too numerous to count. Failed funds have left pensioners high and dry and governments to pick-up the tab. Even pension funds backed by government insurance schemes aren’t immune to this issue. As I noted in my article on the Pension Benefit Guarantee Corporation (PBGC), the government-backed insurance scheme for Multi-Employer Pensions (MEPs) is in dire straights. Anytime the PBGC steps in for a failed MEP, pensioners receive pennies on the dollar for their pension payments.

Numerous countries from Greece to Argentina have also drastically cut their version of Social Security for retirees when they run into budget troubles. Some have done it multiple times. As JL Collins points out, even the U.S. has slowly moved the goalposts over time. This includes raising the age at which people can claim Social Security and the taxes that fund it. Despite those moves, Social Security is in trouble. According to the Social Security Administration’s website, without an overhaul, the trust fund which backs Social Security will be depleted by 2034. Assuming nothing changes, from that point until 2092 Social Security will only pay out 75% of what it owes to retirees.

The Counter to the Counter-Arguments

As I said, I can understand the hardcore FI rely on your own money sentiment up-to-a-point. That point is when it crosses from the prudent to the absurd. I just quoted the SSA’s projection that even through the end of this century, Social Security will still pay out 75% of what is owed — assuming absolutely nothing is done from the political side to fix the problems. Thus, the worst case scenario is not that Social Security won’t pay out, but that it will only pay 75% of what you’re owed.

75% of what you’re owed is still real money. I just ran the numbers, and that takes my estimated $14.5K down to $10.9K a year at my full Social Security retirement age. Would I prefer $14.5K a year to $10.9K? Hell yeah, but I’m not going to bank on the higher figure since it requires political action. At the same time, given the SSA’s own projections, the $10.9K sum seems like a prudent figure to use in my retirement calculations. The SSA has some of the best actuarial data, and therefore projections, within the U.S. government. I’ll be long dead before SSA can no longer support 75% of owed benefits.

The Question

Stick with me here. I’m about to explain how planning for a reduced amount of Social Security, vice no Social Security, relates to how long a person works. Hopefully, by now you’ve heard of the 4% Safe Withdrawal Rate (SWR). If not, check out the link in the previous sentence. If you’re too lazy to do that, just understand that research shows a person retiring in the U.S. at the normal age (65) with a 50/50 stock-to-bond investment portfolio can withdraw 4% annually from their retirement portfolio without depleting it. Utilizing the 4% SWR in this manner comes with a 95% chance of success, which is apparently important to the statistics nerds out there (which I’m not). The bottom line is that it’s highly likely that normal retirees who utilize the 4% SWR won’t run out of money in retirement.

Now, there’s a lot of nuance to the 4% SWR. If this is first heard for you, please research it some more, before you decide to retire with a 50/50 portfolio and start making withdrawals. In fact, my long-time readers will know that as a prospective early retiree, I subscribe to the 3.5% SWR proposed by Big ERN over at the Early Retirement Now blog. However, this example’s sake, let’s use the 4% SWR since it’s a far more accepted figure. With that said, how much money do you think I would have to accumulate in order to employ a 4% SWR and created $10.9K annually?

Mathematically my question looks like this:    .04 * X = $10,900

Solving for X, the equation looks like this:        X = $10,900 / .04

The Answer

The answer is a whopping $272,500. In other words, if I were about to retire, but assumed that Social Security wouldn’t be there, then I’d have to save an extra $272,500 in order to replace my $10.9K annual Social Security payments. Now, for a family like mine which has averaged savings of approximately $45K annually, that means I’d need to work an extra six years. For a 3.5% SWR, those figures go up to roughly $311,500 and 7 years, respectively.

F that! Absurd indeed.

What Would the Golden Albatross Do (WWTGAD)?

A true Golden Albatross would act prudently, not absurdly. What’s prudent in this case? As JL Collins points out, if you’re over 55, then you can probably count on Social Security being there in full. If you’re under 55, you can count on at least 75% being there for you. I think that’s sound advice, which makes the conclusion to his article all the more strange. As he points out, only truly fearful people think Social Security will collapse completely, and that’s not him.

I’ll go further and say that those who think Social Security won’t be there at all are the same ones stocking up on gold, water, and lead for their doomsday bunker. They’re betting the U.S. won’t be around in the future, let alone the Social Security Administration. Historically speaking, betting against the future of the U.S. has proven a losing proposition. Thus, I’m betting this time proves no different.

My Bias

Of course, I say that as someone with a U.S. Federal pension coming my way. I’ve made my peace with the idea that my financial future is inextricably linked to the future viability of the U.S. as a “going concern”. The way I see it, if the long-term viability of the U.S.A. ever comes into serious question, then we’ll have bigger problems than determining whether or not our social security will be there.

With that said, I’m not advocating that you assume 100% of your benefits will be there for you for retirement; especially if you’re under 55. It doesn’t seem prudent to imagine that all of Social Security’s problems will be fixed, even though the proposed fixes seem relatively simple. No, I’d say that given the math problem that Social Security faces, and the political gridlock gripping our system, that it’s far more prudent to assume that nothing gets done. In that case, 75% will become the new 100% for people who start to claim around the year 2034.

A Positive Note for Early Retirees

I certainly hope that Social Security gets fixed for those of us claiming after 2034 because I won’t be able to claim until well after that date. However, my plan currently incorporates the 75% payout as opposed to the 100% payout. The good news is that Social Security is so far off from my proposed retirement date, that the impact from 75% payments vs. 100% payments is almost negligible to the likelihood of my retirement plan’s probability of success. This is borne out when I run my 75% Social Security retirement budget through Flexible Retirement Planner (my retirement calculator of choice) and compare it to the 100% Social Security retirement budget. The probability of success only drops 1% point, from 99% to 98%.

Why is that? Well, Big ERN from Early Retirement Now has a rather complicated mathematical article that explains the impact that annuitized payments (Social Security, pension, or annuity) play at various stages of retirement. Spoiler alert! His math and simulations show that annuities that start later in retired life (like Social Security) play a much smaller role in the success of an early retiree’s financial plan than they would for someone retiring at a normal age like 65. Why? I don’t freaking know, because I’m not a mathematician!

“But I Did Stay at a Holiday Inn Express Last Night”

However, I’m able to read. From what I gather by reading the article is that if annuitized payments begin immediately at retirement, then they play a hugely important role in the overall probability of success for a retirement plan employing a 3.5% SWR. Alternatively, the further separated the retirement date is from the start of annuitized payments, the less impact the payments play in the overall chance of success for a plan that employs an SWR. It’s something I’ve called the Immediacy effect in previous posts.

What does that mean in practical terms for someone like me whose pension pays out immediately upon retirement? It means that even a small bump in my annual pension payment at the start of retirement, say from my disability assessment, is far more important than a potential 25% cut to my Social Security payments 20+years in the future. Even though I can’t draw the formula myself, I can attest that the effect persists throughout all of my retirement simulations. Ain’t it great how math works like that!

Conclusion

Assuming you’re a future pensioner (I mean why else would you be reading this blog?), you’re probably somewhat familiar with the fact your pension has some risks associated with it. If you’re not, then you should get familiar with the fiscal health and future safety of your pension fund real quick. If nothing else, start at Part 1 of my Pension Series. After all, who wants to grind away at a job where the pension fund won’t be there in retirement? That said, other than a few exceptions, we all have to pay Social Security taxes. Thus, many of us are grinding it out for a potentially reduced Social Security payout no matter what.

Other than active participation in the political system whose responsibility it is to overhaul Social Security, I don’t see much that you or I can do about that pending reduction. However, we can plan for it. Not only that, but we can prudently plan vice absurdly plan for it. To absurdly plan would be to dismiss the likelihood of any sort of Social Security payout in your retirement budget. To prudently plan, would be to incorporate a 25% reduction to whatever your current Social Security projection is. That assumes you’re retiring at or after the year 2034. That’s what JL Collins otherwise well-written article should’ve recommended, and it’s definitely what I recommend.