Have you heard the latest news on social security? The social security trust fund will be short on funds three years earlier than last projected. The retirement and disability fund is now projected by the Social Security Board of Trustees to be short on funds starting in 2033. By law this means that all of those who receive benefits will have their benefit payments cut by an amount necessary to restore the fund to solvency. This is across the board for everybody. Currently this amount is right around 25%.
Of course, the law can change. Also, Congress can pass a law to move more money into social security from other sources. My own view is that Congress will change the law capping social security retirement payments at around $20,000 per year. Today the maximum is about $30,000 per year. But the future is unknown and it is best for everybody to assume that they will receive less than expected from social security.
A good estimate to use in terms of how much social security might be cut is the 25% figure I cited. How big of an impact will this have on a typical couple in retirement? I took a look a 45 year old couple in our retirement planner. I assumed that they plan on receiving social security at age 67 and they think they will get a combined $35,000 per year. They currently have $300,000 in assets with half in 10 year treasury bonds and the other half in equities. They save $10,000 per year, I assume a total return for treasuries of 2% per year and for equities I assume 5% per year. They will spend $45,000 per year in retirement (in today’s dollars) and inflation is assumed to be 3% per year. Lastly, I assumed they will live until age 95. I found the following:
| Age When
Funds Run Out | Investment Balance At
Age 95 (In Today's $) |
| Never | $130,190 |
This couple is in pretty good shape. They will never run out of money and they will have over $130,000 at the end of their plan. But what if social security is cut by 25%? I ran multiple scenarios, cutting social security by various amounts to see the impact on their plan. Here is what I found:
| Social Security Cut By | Age When
Funds Run Out | Investment Balance At
Age 95 (In Today's $) |
| 0% | Never | $130,190 |
| 10% | Never | $27,300 |
| 15% | 95 | $0 |
| 20% | 92 | $0 |
| 25% | 91 | $0 |
| 30% | 89 | $0 |
| 35% | 88 | $0 |
If social security is cut by the expected 25%, this couple is now in trouble. They went from a very secure retirement with a large safety cushion of money at the end of their plan to running out of money when they are 91 years old.
The question now becomes, what can they do to make up for a 25% cut in social security payments such that they never run out of money? Let’s start by having them save more money starting today. How much more would they have to save each year in order to completely make up for the social security cuts? After running a few scenarios I found the answer to be $4,000. For some this is feasible, for others there is no way they can save $4,000 extra per year.
They could also of course cut expenses in retirement. How much would they have cut expenses by to make up for the social security shortfall? The answer is 15%, or $6,750 per year.
Neither the extra savings nor the cuts in spending sound too enticing. But there is another way. What if this couple moved half of the money they have in treasuries to dividend paying stocks that have a relatively high yield, strong dividend growth, and a history of increasing their dividends through time? Can the dividend income in retirement make up for social security?
I took their money invested in treasuries and invested equally in four of my favorite dividend paying stocks: Wal-Mart (WMT) with a dividend yield of 2.7%, Johnson & Johnson (JNJ) with a yield of 3.5%, Coca-Cola (KO) with a yield of 2.7%, and Procter & Gamble (PG) with a yield of 3.5%. To be conservative I will assume these stocks see no increase in their stock prices for the next 20 years. Let’s see what happens given various growth rates in these companies’ dividends:
| Growth Rate
Of Dividends | Age When
Funds Run Out | Investment Balance At
Age 95 (In Today's $) |
| 2% | 94 | $0 |
| 4% | 95 | $0 |
| 6% | Never | $39,000 |
| 8% | Never | $112,000 |
With no increase in the stock price and 6% increases in dividend payments per year, this couple will never run out of money in retirement. Each of the stocks I mentioned have five year dividend growth rates above 8%.
If this couple simply takes half of the money ($75,000) that they have in low yielding treasuries and move it to solid dividend payers, their retirement will be much more secure, even if social security is drastically reduced. The scenarios I’ve run today show the importance of beating inflation over time, which treasuries are not doing currently, as well as investing in growing dividends over time. With this strategy, you can be much more secure in retirement.