Social Security Cuts May Come in a Form You Don't Expect

Key Points

• Many Americans fear that Social Security is going to run out or not provide promised benefits.

• It's very unlikely that there will be a direct reduction in the amount of benefits provided to retirees.

• Benefit cuts could happen, but many people won't realize the impact.

• The $23,760 Social Security bonus most retirees completely overlook ›

Social Security benefits are an important income source, but many younger Americans are worried that they won't receive the money they have been promised. In fact, a majority of older Americans anticipate benefits will run out during their lifetime.

This fear isn't entirely unfounded, given there are warnings every year from the program's trustees that the program's trust fund is running dry and an automatic reduction in benefits is on the table.

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In reality, though, Social Security retirees are very unlikely to experience an across-the-board cut in benefits where they lose a percentage of their income. That doesn't mean cuts won't happen, though. They are just likely to take a form many people won't expect.

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This is the most likely form Social Security cuts will take

Social Security is, sadly, facing financial hardship, so those who express concerns about its role in their retirement planning have justification for their fears.

Lawmakers are going to need to take some type of action to make sure that seniors still get this guaranteed source of inflation-protected lifetime income without a huge automatic cut. And they are very likely going to do that since no political party wants to be the one responsible for a big decline in Social Security benefits.

Unfortunately, one of the most likely ways that lawmakers will do that is by changing the full retirement age when you can claim your full Social Security benefit.

Lawmakers made this change when they reformed Social Security in the 1980s, moving Social Security's full retirement age from 65 all the way to 67, although that change has been phased in over many years. This idea of moving the FRA has also been on the table in more recent discussions about Social Security reforms.

While this may sound like a minor or even a technical change, it's not -- it's a pretty big benefit cut, even if it could end up flying under the radar for people who don't fully understand the ins and outs of Social Security.

Why a change to full retirement age is a de facto benefits cut

A change to full retirement age effectively results in a cut to benefits because you have to reach your FRA in order to be able to claim your full benefit. If you claim ahead of your FRA, benefits are reduced.

Any month you claim ahead of your FRA results in a cut to your standard benefit, and that cut gets bigger the earlier you claim. For example, if you claim benefits one year ahead of schedule, this results in around a 6.7% benefits cut. If you claim five years early, then you get hit with a 30% cut.

If FRA is moved later, this puts retirees in a tough position. They'll either need to:

• Put off a benefits claim -- either by waiting to retire or taking more money from retirement plans to make up for not having Social Security -- and end up missing out on months or years of income they'd have otherwise had if FRA hadn't changed.
• Claim at the time they originally planned, which is no longer their FRA, and accept a reduced benefit for the rest of their lives.

Neither of these options is great, and both mean you could end up relying more on your 401(k) or other retirement plans, either to help fund your entire retirement until Social Security kicks in or to make up for the reduced benefit.

If this change happens, current retirees are not likely to be impacted because it's likely the shift will be phased in again. But future workers should be on the lookout for this under-the-radar benefits cut as it could have a big impact on their retirement security.

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