How will Obama's budget affect Social Security?

There’s nothing like proposed changes to Social Security limits to get readers of this column going. After President Obama released his fiscal 2014 budget, a number of you wrote in asking, “What will this mean to me?” Let’s start with a quick refresher on the current system. To qualify for Social Security retirement benefits, you need to have worked and paid payroll taxes for at least 10 years. You can check the online benefits statement to determine where you stand.

Full retirement age varies from 65 to 67 depending on the year of your birth. The general rule is that if you can afford to do so and you are in good health, it pays to wait until your Full Retirement Age (FRA) before you claim benefits (and even better if you can delay until age 70). While you can choose to tap into the system as early as age 62, your benefit will be permanently lower - for some as much as 25 percent less, which also could affect a non-working spouse, who also will claim based on your work history. Unfortunately, many Americans can’t afford to delay – they need the income as soon as possible.

There is one more part of the equation. The government adjusts the amount of your retirement benefit annually to account for rising prices. In 2013, the cost of living adjustment, or “COLA” was 1.7 percent.

Let’s hit the pause here. Social Security is not going broke imminently. Yes, there are fewer workers paying into the system today and indeed, more and more baby boomers retire every day. The Social Security 2012 trustee report projected that in 20 years (after 2033) payroll tax income would be sufficient to pay only about three-quarters of scheduled benefits through 2086.

But the trustees’ report offered a different way to think about Social Security -- as a share of Gross Domestic Product, or the economy as a whole. Program costs equaled 4.2 percent of GDP in 2007, and the Trustees project that these costs will increase gradually to 6.4 percent of GDP in 2035 before declining to about 6.1 percent of GDP by 2050 and then remaining at about that level.

Many argue that 6 - 6.5 percent of GDP is a small price to pay to fund a program that provides about 37 percent of all income for Americans 65 and older and a whopping 85 percent for those in the bottom 20 percent of incomes. That’s why legislators and pundits have been floating so many ideas for enhancing the current system, which include increasing full retirement age; raising the Social Security wage base from the current level of $113,700 of earned income; increasing the Social Security payroll tax for high earners; means-testing Social Security benefits for retirees who have incomes above some threshold; and changing the cost of living adjustment.

The President’s budget focuses on the last choice, by tinkering with the COLA calculation as a means to slow down the cost of the Social Security over the next decade. The proposal would replace the current measure of inflation (a consumer price index for wage earners, or CPI-W) with one called  “chained CPI,” which the government has only been calculating since 2002. Advocates claim that chained CPI is a more accurate measure, because it takes into account that consumers respond to the rise in the price of one good by shifting to cheaper alternatives.

Chained CPI has shown an average rate of inflation that’s 0.3 percent lower than the government’s current measure, according to the AARP Public Policy Institute. The Obama Administration says that the change in calculation would shave $110 billion from the budget over 10 years.

However, what would be the net effect of this change on retirees? According to the Center for Economic and Policy Research, the switch to chained CPI could reduce benefits for the average worker who retires at age 65 by about $650 per year by age 75, and by over $1,100 per year by age 85.

So, while some combination of these proposed changes could be made to bolster Social Security over the long term, many of them will shrink the already meager benefits of most retirees. Like it or not, this appears to the new reality of retirement. We should all pay attention and plan accordingly.

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