Planning for smaller Social Security checks

NEW YORK (Money) -- I've heard that the government might "means test" Social Security so payments would be reduce or eliminated for people with higher incomes. Do I understand this potential threat to the Social Security component of my retirement plan correctly? -- W.P., Bellevue, Washington

Unless you or someone else has a spare $6.5 trillion to throw into Social Security's coffers -- which is the amount the trustees' report released last Friday says the program requires to put it on firm financial footing -- something's gotta change.

Of course, we've known this for years. But politicians prefer to dance around Social Security's funding problem until it gets so bad they have no choice but to act. The last time that happened was in 1983, when a number of significant changes were made on the recommendation of the Greenspan Commission.

But time appears to be running out again.

Aside from that $6.5 trillion shortfall, the latest Social Security trustees report outlines a number of disturbing developments, including the fact that for the foreseeable future, payroll taxes will no longer be enough to pay benefits.

That means Social Security will be relying on the federal government for dough to pay retirees and other beneficiaries. The money will first come from interest on Treasury bonds held by the Social Security trust fund. But within 12 or so years, the program will have to start redeeming those bonds.

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In a purely accounting sense, that's not a problem. The Social Security trust fund owns Treasury bonds that pay interest and can be redeemed for cash. But as a practical matter it is a problem.

Why? Well, it's not as if the government can turn to aliens from outer space get the moulah to pay the interest and principal on the Treasury bonds Social Security owns. To come up with the money, the federal government will ultimately have to turn to its usual go-to source whenever it needs revenue to fund programs and repay the money it borrows: you and other taxpayers.

I don't want to be an alarmist. Even after all the trust fund bonds are gone, there will be enough money coming in from payroll taxes to pay about 75% of scheduled benefits. But unless something changes, in 25 years or so, there won't be enough money coming into the program to pay more than that.

Which brings us back to your question.

I don't know of any serious Social Security reform proposal that would eliminate payments to affluent people.

But reduce payments? Yes, there have been a number of plans over the years that have effectively called for smaller Social Security checks, and not necessarily just for the wealthy.

For example, the National Commission on Fiscal Responsibility and Reform's December 2010 report recommended, among other things, gradually changing the formula for calculating benefits to make it more "progressive." That would result in lower payments for both middle- and upper-income workers.

Others have proposed reforms ranging from raising the age at which you can qualify for full benefits to boosting the payroll tax rate to expanding the amount of pay subject to Social Security payroll taxes to personal accounts.

At some point, Congress and some administration will have to come up with a fix. Ideally, that should happen sooner rather than later, but I have no idea when it will be. Nor do I know what that solution will be proposed.

My guess, though, is that it will involve not one but a series of adjustments along the lines of those mentioned above that, ultimately, would reduce benefits somewhat for all but the lowest wage earners.

I would also expect that most, if not all, changes would be phased in so that people already on Social Security or close to taking it wouldn't take a hit, or at least not a big one.

Fact is, though, no one really knows what modifications we'll see or when we'll see them.

But I think it would be naïve for most people planning for a retirement that's still many years away to assume they'll collect Social Security benefits as scheduled now. It's more prudent to assume that, one way or another, benefits will be diluted.

All the more reason to go to a tool like our Retirement Planner to make sure you're on track to a secure retirement. And even if you find you are, it makes sense try to save even more in 401(k)s, IRAs and other retirement accounts to give yourself a bit of an extra cushion.

We've been kicking the Social Security can down the road for a long time now. But you can't continue doing that when you reach the end of the road. It looks like we may be running out of road.