Shrunken Social Security figures into advisers’ plans

Anticipating a cloudy future for Social Security, many financial advisers are taking steps to de-emphasize the program’s place in clients’ retirement income plans.

“We’re telling clients who are over 70 and already receiving benefits that they are probably OK,” said Michael Kresh, president of Creative Wealth Management LLC. “But if they’re younger, we’re preparing them to have Social Security be a smaller part of their retirement, and helping them do whatever is necessary to squeeze every dollar out of the system that they’re entitled to.”

Confirming many advisers’ fears, the Social Security Board of Trustees last week said that the federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds are expected to be exhausted by 2033, three years earlier than last year’s estimate.

LONGER TIME HORIZON

That time horizon may be far enough in the future to ease the worries of their newly retired clients, but advisers are looking around the corner on behalf of clients who are a decade or more away from retirement. Many advisers, anticipating federal austerity measures, are sharply curtailing projections for income from Social Security benefits for clients in their 40s and 50s.

Specifically, that means acclimating those investors to the prospect of receiving smaller benefits, no cost-of-living adjustments and, in some cases, no Social Security benefits at all.

“We tell 35-year-olds to assume it won’t be there,” said David L. Blain, president and chief investment officer at D.L. Blain & Co. LLC, who looks at Social Security for his younger clients as icing on the cake.

Given the program’s finances, it only makes sense that advisers establish pessimistic predictions for benefit payments from Social Security, said Laurence J. Kotlikoff, an economics professor at Boston University and author of the upcoming book “The Clash of Generations: Saving Ourselves, Our Kids and Our Economy” (The MIT Press, 2012).

Social Security is underfunded by 29% and the program’s liabilities have ballooned by 14.5% since last year, he said.

Battles between political parties on taxes and tax cuts also have helped starve the program, Mr. Kotlikoff said.

The economist thinks that when the time comes to trim Social Security benefits, the wealthiest clients will feel the pain first, as they will take the most drastic cuts.

“Planners need to think about being conservative with their clients,” Mr. Kotlikoff said. “Someone who is 55 might see a 20% [benefits] cut, and that’s a big deal.”

Some advisers are telling clients in their 50s and younger to expect just 75% to 80% of their promised benefits.

David E. Hultstrom, president of Financial Architects LLC, assumes that the Social Security benefit will grow at 1% less than the inflation rate, with bigger benefit haircuts coming in future years.

To help “replace” predicted shortfalls in Social Security income, he recommends that clients invest in Treasury inflation-protected securities.

“Social Security is a fixed-income investment, so if you are replacing it, you would invest in fixed income,” Mr. Hultstrom said. “TIPS are the best proxy.”

Advisers noted that while less affluent Americans depend on Social Security benefits to a greater degree than their typical clients, even modestly affluent investors expect to receive benefits and for those benefits to contribute a significant share of retirement income.

Indeed, the prospect of a steep decrease in Social Security income or higher taxes on benefits is frightening.

MODERATING PAYMENTS

“The presumption with the wealthier clients is that they expect Social Security to be there,” said Mr. Kresh, who thinks that the government will tinker with the cost-of-living adjustment on Social Security benefits as a way to moderate payments and help stretch the federal fund.

When drawing up plans for clients who are retiring, he shows them one plan that assumes a Social Security COLA of 2.5% and another assumption that leaves out the adjustment.

The difference in outcomes is massive: One of Mr. Kresh’s 60-year-old clients has a private pension with no COLA and expects to take Social Security at 66. In one scenario, assuming a 2.5% COLA on his benefit payments, the investor should reach 90 with $1.4 million in assets.

In a scenario in which the COLA adjustment is in place from 66 to 70 and then ceases afterward, the client arrives at 90 with just $550,000 in assets. This is the result of drawing down more of the investor’s assets to make up for the rising cost of living.

“People need to know that if income is shrinking, they’ll be dipping into their principal sooner,” Mr. Kresh said. “Once you start doing that, you go off the cliff quickly; it’s the difference between running out of money at 82 and running out at 92.”

Jim Saulnier, who runs an eponymous advisory firm in Fort Collins, Colo., agrees.

“We tell our clients that removing the COLA adjustment is the low-hanging fruit that Congress could implement when dealing with the inevitable insolvency of the trust fund,” he said.

Still, not all advisers think that a cut in benefits is a major concern.

“For a typical client, where Social Security may be a quarter of the retirement income picture, it’s not really a dramatic change in the grand scheme of retirement,” said Michael Kitces, director of research at Pinnacle Advisory Group Inc.

Nevertheless, he assumes a 10% to 20% haircut in Social Security benefits for people who are more than 10 years away from retirement.

Recommending that investors wait until 70 to receive their benefits is a tactic that many advisers already have been taking. Others are trying to maximize the amount that their clients can get through Social Security-claiming strategies.

Dean Barber, founder of Barber Financial Group, is encouraging clients in their 40s and 50s to assume that they will have to wait longer to start collecting benefits.

“Take what you think you’re going to get at age 62 and instead assume that that’s what you’ll get at 66,” he said. “If you make sure your retirement plan still works with your benefits coming in later, then you’ll have a little flexibility.”

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