The following article by Robert Schmansky, CFP® was originally published at Forbes.com.
Perhaps my favorite aspect about providing financial guidance for a living is that I am an outside observer. I can review a client’s strengths and weaknesses, opportunities and threats, and provide thoughts on all without accepting the consequences of these choices.
As an outside observer, it is important to discuss all material risks to a plan, and not to gloss over pieces like Social Security that have a significant impact on the future success of most retirees plans.
More and more when it comes to Social Security observations, I find planners and parts of the financial media take one position – that Social Security is strong and should be counted on by all.
Though speaking about the third rail of politics is supposedly only damaging to political careers, it seems to be a topic that few in the financial advice business dare to take a serious look at. Articles go even further to claim that Social Security is in better shape than we think (which, I’m not certain what that means). Opinions stick to screened information, never to dare engage a fact outside of agency and government press releases.
This attitude reflects more of a bias than that of the outside observer. Social Security is now counted on as an “everyone else’s” pension plan, and it is critical to understand not only the possible strengths of it within a retirement plan, but also the risks of projecting for it in full.
Advisors can even look at all of the ways pensions have changed to discuss the possible future of Social Security. Anyone who was a part of a pension plan likely has seen some changes to their benefits over the last few decades. Some of the most rewarding advice I have been able to give to clients has been to discount pension benefits that later were reduced.
Here in Detroit, “PBGC Risk” was a term created for the risk of a pension not paying out in full amount should it be frozen or turned over to the PBGC where a lower benefit would be paid. If PBGC Risk is something retirees should plan for, Social Security risk is as well.
And while we can not know how much of our Social Security benefit is at risk, we do know there are significant risks to consider. There is an inflationary risk of the trust assets being redeemed, a risk that the retirement age will be raised and more private savings necessary, and the cost-of-living formula being adjusted to lower payouts.
An additional risk that proponents may have discounted for over the last decade is their reliance on Social Security’s actuarial predictions. A recent study by Harvard and Dartmouth researchers show that the projections that just about all of the proponents rely on to discuss the strengths of the program have been less reliable since they year 2000; and while the study does not say it.
What can you do to combat Social Security risk?
1) Diversify broadly, including maintaining equity exposure. Include a healthy amount of foreign equity, real estate, and bonds.
2) Invest and save more while you are able to.
3) Don’t count on your Social Security payout to be 100% in real terms going forward. In your projections keep your payment growth at less than inflation and review scenarios with lower payouts.
Financial advisors who ignore the risks to Social Security may be providing current relief to the retirement hopes of their clients, but it could be to their long-term financial wellbeing.