Educate clients on the reality of Social Security benefits

Year after year, despite handwringing from experts, nothing much seems to happen to address the draining of Social Security trust funds. Perhaps no one is worried because the well won’t run dry for more than a decade, and much of the public is resigned to a partisan Congress unwilling to compromise on anything controversial until a crisis is imminent.

The main Old-Age and Survivors Insurance Trust Fund continues its inexorable march toward depletion — the latest Social Security Board of Trustees’ annual report pegs it at 2035.

But higher taxes, delayed retirement age and means-testing all may be part of the solution mix. Barring some unimaginable catastrophe, the system won’t go bust or renege on its societal commitment to pay participants a benefit, even if that benefit turns out to be smaller than participants anticipate.

What many don’t appreciate, though, is that lower Social Security income is not just a possibility for the 2030s. Right now, millions of Americans on the cusp of retirement or in early retirement are finding that their monthly income from the benefit is lower or will be lower than what they anticipated. And that poses challenges and opportunities for financial advisers.

To no small degree, much of the disappointment that many Social Security beneficiaries experience comes from a misunderstanding of the system’s benefits and rules. As InvestmentNews contributing editor Mary Beth Franklin recently noted, most future retirees are misinformed about the age of eligibility for full retirement benefits, with 70% of those surveyed by the Nationwide Retirement Institute believing they are eligible for full benefits earlier than they actually are. In addition, most expect they’ll receive an average of $1,805 a month in benefits, when in fact the current average is $1,408 — a 28% difference.

But wait — to paraphrase infomercials — there’s less!

As much as they are confused or misinformed about their Social Security benefits, pre-retirees are probably even more confused about Medicare and how much its Part B premiums, which are deducted from each monthly Social Security payment, will cut into their expected income.

This year, the standard Medicare Part B monthly premium is $135.50. But since the premium is based on modified adjusted gross income taken from an individual’s tax return two years earlier, someone who just retired could face significantly higher Medicare premiums if his or her income was at a peak during their last years of working. An individual filer who reported income between $133,501 and $160,000, for instance, would pay a Medicare premium of $352.20 a month.

To be sure, those with higher incomes are likely to receive higher-than-average Social Security benefits as well, but income after the Medicare deduction is still likely to be sharply lower than expected, and that’s before the impact of federal and state income taxes in retirement, which many about-to-be retirees ignore or underestimate as well. A retired married couple where both spouses receive Social Security and take distributions from qualified retirement plans can wind up with a hefty tax bill.

Advisers have an important role to play in educating their clients about the realities of Social Security and Medicare. Discussing claiming strategies and explaining the nuances of how each client’s unique circumstances can affect benefits provides tremendous value. Offering other income solutions through investment choices, as well as practical noninvestment advice to increase income, such as how to find satisfying part-time work in retirement, can also be a welcome way to help clients face any personal Social Security “crisis” of confusion that may arise.