Results of a recent Social Security Administration (SSA) audit by the Inspector General, published on February 14, 2018, show that the federal retirement benefit program is underpaying widows—and other groups of beneficiaries.
This is “a huge U.S. retirement security issue,” warns William Meyer, founder and managing principal of Social Security Solutions in Leawood, Kansas, and one which he in fact discussed in front of the U.S. Senate about a year ago. Since then no action has been taken on the subject by Congress or the Trump administration, he notes.
“To put the problem simply, the SSA does not have the necessary tools and analysis to notify widows of when they could switch from survivor benefits back to their retirement benefit to secure more money,” Meyer warns. “There is a flaw in the system such that the Social Security agents don’t have the ability to recommend the strategy in question, in part because they don’t have the training needed to recognize this situation and also in part because they are not even really allowed to give ‘advice’ or ‘recommendations’ in the first place. They just give ‘information,’ and so this potential strategy is not being taken advantage of by this quite vulnerable population. It’s a real shame.”
Meyer is following the issue closely because his firm is in the process of rolling out what he hopes will be a groundbreaking Social Security claiming optimization software product that comports directly with defined contribution (DC) retirement plans. More on this is available on the firm’s website.
“We are coming to market now with a new software product that coordinates the claiming of Social Security with portfolio drawdown decisions in the defined contribution plan arena, so it is a great time for us to get acquainted with your readership,” Meyer says. “This is a topic that I have seen a tremendous amount of interest in from all the stakeholders—advisers and consultants, plan sponsors and participants. Our big pilot clients so far include Vanguard and Northern Trust, and other firms as well, including Financial Engines.”
Meyer suggests that, to date, a lot of the “big successful DC plan recordkeepers” are not really including sophisticated Social Security or tax considerations in their planning capabilities.
“This is a problem because we can show that, by optimizing Social Security decisions and better tying these to the DC plan drawdown and rollover decisions, a given plan participant can make their money last between two and 10 years longer,” Meyer says. “It can be that dramatic. Unless you’re in the top 1% of income earners, when and how you claim Social Security is, in a very real sense, the largest single financial decision of your lifetime. So it should be no surprise, given how little advice is available out there are on this topic in particular, that people are not making optimal decisions. It is vastly complicated.”
Meyer recalls that, earlier in his career as he first started researching how his firm could build some software methodologies to help manage Social Security planning, it immediately became clear that the choices around Social Security would be much more complicated than anything faced on the accumulation side.
“There are something like 3,000 rules and 20,000 pages of explanatory material that set out all the different claiming strategies and possibilities for drawing Social Security,” he says. “It is an area where software and artificial intelligence can really shine. One other thing I want to say: There are a lot of free Social Security tools out there right now that are just not sophisticated at all. They might consider a small number of inputs and then pick from perhaps three or four possible strategies. The type of tool we are bringing to market considers and compares thousands of possibilities for each individual. This is not a part of the planning process where we can cut a corner—the details matter so much to the quality of the advice on the Social Security question.”
According to Meyer, what has also proved to be interesting as the firm has looked to the 401(k) space is that there is some discomfort among plan sponsors and advisers with the fact that the way participants will claim Social Security can be “lumpy,” making point-in-time education or advice a tricky proposition.
“By that I mean that there are oftentimes situations where, whether you decide to file earlier or later, this will directly impact the way you start tapping down other savings down the line, both the tax-deferred money in the 401(k) and any other after-tax sources,” Meyer says. “And then your marriage or life situation can change. If you’re married or divorced, you can often get survivor or spousal benefits before you actually start to draw your full benefit, which can kick in as late as age 70. So what we tell plan advisers, sponsors and participants is that, the way people decide to draw Social Security will have a direct impact on delineating the way they draw all their other assets. It’s going to impact your risk tolerance in investments, what type of return you’re expecting to see, etc.”
Meyer says there is actually evidence that people are getting “not great advice” on this subject.
“The conventional wisdom on how someone should draw down their various assets to maximize retirement income—used by all the big recordkeepers, by the way—is that you should take all your taxed money first until it’s gone, and only then do you take all your tax-deferred money until it’s gone. Finally you take the tax-exempt dollars,” Meyer observes. “That rule of thumb is pervasive, but we can now show, using our software, how this is actually typically the opposite approach of what would maximize lifetime wealth for a given individual.”
Why is this? According to Meyer, when one retires, on average he will drop into a lower tax bracket, because he is moving out of his prime earning years and instead starting to live off savings. Then the logic goes as follows: “As you hit the age where you start drawing full Social Security at 70, that’s right about the time when required minimum distributions [RMDs] kick in. When that happens, we often see people’s income jump up pretty significantly, and as a result their Social Security benefits that they waited to claim will be taxed at potentially up to 85%, because this rate is based on withdrawals from the IRA or 401(k). So, the point is that by winnowing down the 401(k) or IRA first, while you are waiting to file Social Security, this reduces the lifetime impact of RMDs and reduces the taxes, potentially quite significantly, on the income from Social Security.”
It’s a complicated matter to discuss in the abstract, Meyer concludes, “but the example at the very least shows how you claim Social Security and how you coordinate this with all the other decisions about drawing income from the 401(k) or IRA has a dramatic impact on the final outcome of the life-long savings effort.”