An often-overlooked risk in government-sponsored benefits, including tax-favored savings and retirement plans, is the possibility that the rules will change. In practice, the “possibility” is more likely an “inevitability”: the rules will change.
A recent example of government “moving the goalposts” involved options for receiving Social Security retirement benefits. On November 2, 2015, President Obama signed off on legislation that eliminated three methods of payment permitted under rules passed in 2000. The most significant change was the elimination of the “file-and-suspend” strategy.
How File-and-Suspend Used to Work
File-and-suspend allowed someone, upon reaching full retirement age (FRA), to file for Social Security retirement benefits, then immediately suspend them. For each year a retiree deferred benefits, they were credited with an 8 percent increase in retirement income. At the same time, a benefits-eligible spouse could immediately begin receiving a spousal benefit (defined as one-half of the retiree’s monthly benefit).
File-and-suspend was a key component in many retirement plans. Financial institutions even developed software and built marketing campaigns around integrating other assets to best implement this approach. In instances where one spouse had a higher earnings history and was still working, while the other was not working or had lower lifetime earnings, the file-and-suspend option could result in thousands of dollars in additional benefits. A website posting for a law firm specializing in file-and-suspend said, “We often saw couples who could receive over $70,000 in additional benefits.”
But in one swift act, these strategies have been eliminated. Under the new provisions, individuals can still file-and-suspend their personal benefits. But spouses can no longer receive a spousal benefit from an individual who is suspending benefits.
The government claimed that closing this loophole will save the Social Security retirement fund $9.5 billion each year. Bob Rosenblatt, in a November 3, 2015, Huffington Post article said some government officials felt file-and-suspend “gave upper-income retirees a chance to game the system.” Yet Rosenblatt quoted experts who said file-and-suspend was used by “lower-middle-class families with disabled children” and that “women with low and moderate incomes were also important beneficiaries of the strategy.”
As part of a comprehensive budget bill, these changes were apparently hastily inserted, and caught almost everyone by surprise. The first version, approved by the House of Representatives, generated so much negative outcry that the Senate immediately revised or modified some of the provisions, and added a six-month transition period, through May 2016, before the changes will take full effect.
Even with the re-writes, Lawrence Kotlikoff, a professor of economics at Penn University, and expert on Social Security, quickly found several perverse incentives in the new laws. Writing in a November 2, 2015, article for PBS, Kotlikoff observed that some couples would be better off if they got divorced:
The budget deal provides a huge incentive, up to $120,000 in some cases, for married couples to get divorced, “live in sin” and then get remarried at 70. Take a couple in which each spouse is now 63. Neither can file and suspend over the next six months because neither will reach full retirement age by then. But if they get divorced, they will be able, at full retirement age, to each collect a full spousal benefit based on each other’s work records while waiting until 70 to collect their own retirement benefit. You need to be divorced for two years before you can collect on an ex, so this couple would have to get divorced by 64 in order to start collecting their full spousal benefit at 66. Can working couples under age 62 do the same? No, because they will be deemed to be filing for their own retirement benefit at full retirement age if they file for their divorcee spousal benefit and will end up with the larger of the two amounts.
A financial incentive for divorce is problematic. Even worse, the changes give bitter exes a chance to punish a divorced spouse by withholding benefits. Again, from Kotlikoff:
(A) nasty ex-spouse can cancel the spousal benefits of his ex by filing and suspending even though doing so provides no advantage to himself. Take Sue who was unhappily married to
John for decades before Sue called it quits. John earned a lot of money. Sue earned very little. Sue and John are now both 66. John plans on waiting until 70 to collect his retirement benefit. Sue files for her divorcee spousal benefit. John, who is a nasty person and hates Sue, chooses to file and suspend his retirement benefit, and poof, there go Sue’s benefits for four long years.
Kotlikoff concluded with this stinging critique:
No retiree will ever again be able to feel their Social Security benefits are safe from some backroom, midnight, rushed change in rules that are designed to meet some budget target or accommodate some politician’s whims.
While we might be sympathetic to Kotlikoff’s outrage, these changes shouldn’t come as a surprise. This is how the system works. Based on current exigencies, the government reserves the right to change the rules.
The Prudence of Personal Planning and Private Contracts
These changes underscore the desirability of financial instruments and strategies whose benefits are not so dependent on legislative approval. Many of these “non-governmental” options are contracts with guarantees (such as annuities, life insurance policies, or fixed mortgages) that have clearly specified conditions. Changing the terms of the agreement is difficult, and not something one party can impose unilaterally on the other. And if a financial institution fails to honor its agreement, a consumer can seek legal remedies.
There are some personal finance models that emphasize qualified retirement plans in long-term accumulation strategies. This perspective often assumes tax treatment and participation rules for retirement plans will remain essentially the same for the next 30 or 40 years. Given past history, this is a risky assumption, and not just because of the recent changes to Social Security. Congress has made numerous “adjustments” to qualified retirement plans over the past four decades, concerning things like loan provisions, contribution limits, and required withdrawals.
Government-endorsed benefits are certainly part of the personal finance landscape, and their use and impact must be part of any planning conversation. But relying on their stability just isn’t rational, considering legislators have the authority to change the terms of the deal at any time – and have shown they will.
HOW MUCH IS YOUR PERSONAL FINANCE PROGRAM SUBJECT TO GOVERNMENTAL CHANGE?
DOES YOUR FINANCIAL COURSE HAVE THE FLEXIBILITY TO CHANGE WHEN THE RULES DO?