A psychotherapy client who originally sought consultation for depression due to chronic pain came one afternoon to a session with an interesting dilemma. He said, “I have about eight years before I could retire, and I realize that I know next to nothing about my benefits. I want to think about an early out from work, but with the political environment as it is, I don’t trust that I could quality for ACA [Affordable Care Act] insurance, even if it is still available. I don’t know much about Social Security, qualifying for short- and long-term disability, or when I really should think about any of it. What I understand is that I pay into the system and will be able to reap the rewards when I retire. There must be more to know than that. Could you help me to make the best decisions about what I should do?” I confessed my limited knowledge of the ins and outs of financial planning, since I defer long-range money decisions to my own financial consultant and accountant. As our conversation ensued, I became increasingly interested in my own ignorance and suggested to the client that we pursue a mutual search for information and knowledge.
Social Security and retirement
The question the client brought stayed with me: “What do you really know about your retirement money, in particular, about Social Security?” For most folks, the answer is, “Not much. Certainly, not enough.” This answer is borne out in a 2016 report by the Organization for Economic Cooperation and Development, which reveals that only a little more than half of all adults in the United States can answer five of seven basic questions about financial knowledge, such as “Are you better off delaying taking Social Security for as long as possible?” and “How much do I need to save to be able to retire?” Typically, as was the case with my client, this translates into financial insecurity, particularly for retirees with health concerns.
According to Emily Guy Birken in her book Making Social Security Work for You, the average late- to middle-age American will have just over $103,000 set aside for retirement. For most people, that means Social Security benefits have to make up the difference. These benefits are the chief source of income for the majority of the elderly, representing at least half of the retirement income for 74% of single beneficiaries and 52% of married couples. The average monthly Social Security payout to retired Americans is a little more than $1,300 per month, according to an article in the November 2016 issue of Time. This is far less than most adults need to maintain their current lifestyle at retirement. Penny Wang, the author of the Time article and an editor-at-large of Money magazine said, “For some 33% of families, the benefit makes up 90% to 100% of their income.” Guy Birken is quite direct, advising, “Don’t rely too much on Social Security. Basing your retirement income solely on Social Security is a recipe for disappointment or a rage stroke if the rules change,” which they probably will in the current political climate and must in the next decade to preserve the system.
Social security is insurance
It seems important to understand at a fundamental level that Social Security is, at its core, insurance. Guy Birken says, “Like private insurance, social insurance helps spread out the risk of an individual loss among a larger group, thereby protecting the most vulnerable in society.” The Social Security Board of Trustees manages reserves that working people pay into. These reserves are used to subsidize and replenish three trust funds — Old Age, Survivors, and Disability Insurances.
Social Security was designed as a pay-as-you-go program. Workers pay taxes, which in turn pay benefits to retirees and other recipients. The system is now running at a deficit and requires changes to remain solvent. Maya MacGuineas, president of the Committee for a Responsible Federal Budget, a nonpartisan nonprofit organization dedicated to educating the public on fiscal issues, says that if Social Security continues paying its current benefits without substantive change, the trust funds will be depleted by 2034. At that point, Social Security will be able to pay only about 80% of scheduled benefits. The surge of Social Security spending is chiefly driven by the aging of the U.S. population.
The leading edge of the Baby Boomer generation of 75 million began heading into retirement at the beginning of the Obama administration. In 2009, the nation’s worker-to-retiree ratio stood at 3 to 1. In 2017, with more Boomers exiting the workforce, the ratio has dropped to 2.8 to 1, and by 2035, it is projected to shrink to 2.1 to 1. As less money comes into the pay-as-you-go structure, the system drains itself. In 2015, 5.4 million people were newly awarded benefits, bringing the total to 60 million receiving Social Security benefits by the end of 2016.
My client was clear — he wanted to retire early but would have to depend on Social Security benefits to survive. In his mid-50s, living for several years with Type 2 diabetes and severe neuropathy, he was interested in beginning Social Security benefits at age 62. He posed an important question about the maximization of retirement benefits: “How do I know if I should do it now or later?” Taking benefits at their optimal time depends on one factor that no one can know — when you will die. When considered in the context of this end-of-life factor, money and Social Security benefits tend to evoke emotional reactions. People are afraid of missing out on any of “their dollars” paid into the system, since that means subsidizing someone else’s retirement without personally realizing benefits. Guy Birken calls this an “investment mindset.” She states that trying to time the maximization by taking early benefits is not the most effective way to gain good returns on investments. She says that investing involves risk that is defined by two elements: the volatility of the investment and the possibility of absolute loss of capital. Viewing Social Security as an investment can lead beneficiaries to believe they are better off taking early benefits. To win from this strategy, the individual would have to die before reaching a breakeven point of investment and return.
Looking at benefits as insurance takes the breakeven analysis off the table. Treating Social Security benefits as a type of insurance policy provides protection from the catastrophe of outliving personal savings. As Guy Birken says, “Having a long life is a wonderful gift, but growing old without enough money to live on is one of the worst things that can happen to a retiree and his family.” Poverty rates among the very old are high, although there is a 2% to 3% reduction in poverty rates for each additional $1,000 received in annual Social Security benefits. “The elderly who live in poverty and their families face extremely difficult decisions and a great deal of stress,” writes Guy Birken. “Treating Social Security as a type of insurance — meaning you want to maximize your protection rather than profit — will allow you to better shield yourself and your family from the danger of falling into poverty.”
Maximizing non-Social Security income
According to current public statistics, 23.7% of Social Security beneficiaries rely on Social Security benefit checks as their sole source of retirement income. While that number is high, the flip side of the statistic reveals that more than 76% of beneficiaries have additional retirement income. As my client drew up a workable budget, he said, “I’m 55, not in great health, and tired of working as hard as I must. But if I am ever going to retire, I have to beef up my savings account.” Careful saving and investing can stretch a retiree’s non-Social Security income to afford delaying the election of benefits, which is generally considered desirable.
Historically, the most common retirement income strategy is the Four Percent Withdrawal Rule. This simple and popular system is based on the idea that an individual can safely withdraw 4% of assets in each retirement year without touching the principal. The strategy assumes that investments will grow by at least 4% each year, so the withdrawal will not impact the principal. Guy Birken states that in contemporary times, the Four Percent Withdrawal Rule places an individual in a vulnerable financial position because the formula is based entirely on stock market volatility. She instead suggests investing using a “bucket method” in which investors divide their portfolio into different income “buckets” to handle a different time period in retirement. Allocation of funds is based on stock market stability, liquidity, and aggressiveness. To make informed decisions about the bucket system, a financial planner is employed to redistribute assets from one bucket to another to continue meeting the goals of each portion of retirement. The one drawback to the bucket system is that a person has to have a relatively sizeable portfolio to take advantage of it.
Do I qualify for Social Security Disability Insurance?
A lovely 60-year-old woman came to see me for counseling and told a story similar to that of my client wanting to take early retirement. She lives with orthopedic and neuropathic pain. “You think you have time,” she said. “I was fine and enjoying my life until a car accident left me with miserable low back pain and sciatica. I had stopped working and exhausted my short-term disability benefits. I’m now using COBRA for insurance and have other medical bills that are expensive for me to pay. My doctor said I would qualify for disability, since I’m not close enough to retirement age for Medicare, but I don’t understand the process and am not happy about the thought of being known as disabled.”
The client had several thoughts about how to make the Social Security Disability system work for her. For those like her who labored so hard paying into the system, it seems vitally relevant to learn what is available as a potential benefit to plan for financial security.
Eligibility for Social Security Disability is based on two tests: the recent work test, which requires a person to have worked at least five out of the previous 10 years, and the duration of work test, which requires earning a minimum number of credits, i.e., quarters of qualified work over an entire career. Both the recent work and duration of work tests have sliding requirements depending upon the age of the beneficiary at the time of disability.
For eligible workers to qualify for Social Security Disability Insurance after becoming disabled, an application for benefits must be filed with the Social Security Administration. Nearly two-thirds (65%) of initial disability claims are denied. The first step of the appeals process, according to Guy Birken, is a reconsideration of the application, although this has an even higher denial rate of 85%. Once a claimant has been denied twice, the applicant can request an administrative law judge hearing. The approval rate of such hearings is much higher — 40% for claimants who do not retain an attorney to represent them and 60% for claimants who hire a lawyer.
My client and I learned that retirement requires financial planning and that the Social Security system is complicated and convoluted. We realized that the program is social insurance designed to help prevent poverty in the elderly and the financially vulnerable. We were reassured that it was originally begun and is still deemed as beneficial to society. Because it is allocated as fairly as possible, it spreads the wealth across older generations, widows, the destitute, and the disabled.
My client has time to learn more about Social Security and dedicated himself to saving a larger nest egg. As he said, “This is the best option for me right now, and I think saving while I am still working is a sound strategy so that I can use the system to gain the most benefit in my retirement years.”
Want to learn more about money matters and chronic pain? Read “Tips for Arthritis Disability Approval.”