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Social Security's First Pay Cut

For the first time since Social Security started offering Cost of Living Adjustments (COLA) in 1975, recipients won't be getting an automatic raise next year. Thanks to a negative inflation rate, combined with a prohibition against downward COLA changes, payments will remain flat for retirees. In addition, those who participate in Medicare Part D will see their Social Security checks drop slightly (about $2 a month), due to premium increases for that program.

As many headlines as that minor nominal payout cut has generated, it's nothing compared to what's in store in the future. The Social Security trust fund is slated to run out of money around 2037, slashing benefits by about a fourth. If you think things are rough for retirees now, just wait until that particular tap runs dry.

Actually, don't wait: prepare
There's little that can be done to stop Social Security's eventual collapse without tearing the program completely apart. The age to get full benefits has already been scheduled to be raised, the tax rates to support it have leapt more than five-fold since the program's inception, and the salary subject to that tax has increased from an inflation-adjusted $45,000 to over $100,000.

Add an aging population and a stagnant economy to this structurally insolvent mess, and it quickly becomes evident that there's no way Social Security will survive in its current form. If you're counting on Social Security to fund a big chunk of your retirement and you expect to live past 2037, you'd better change your plans. Otherwise, you will find yourself in significant financial pain when you're least able to do anything about it.

The sooner you begin, the better
If you're hoping your finances will survive to a ripe old age in spite of the ticking time bomb that is Social Security, there really is no time better than today to start saving for your future. The longer you have before you retire, more time is your ally. The longer you wait, on the other hand, the more time becomes your enemy.

Just take a look at how quickly the amount escalates that you have to sock away each month to reach a million dollars at retirement:

Years to Go

6% Return

8% Return

10% Return

40

$502

$286

$158

35

$702

$436

$263

30

$996

$671

$442

25

$1,443

$1,051

$754

20

$2,164

$1,698

$1,317

15

$3,439

$2,890

$2,413

10

$6,102

$5,466

$4,882

5

$14,333

$13,610

$12,914

Not even a shift to the more aggressive 10% return side of that chart changes the fact that the more time you have on your side, the easier it is to come up with the cash to reach your goals.

But the market is scary
While it's absolutely true that there are no guarantees in investing, over the long haul, the stock market has produced incredible amounts of wealth. In addition, you can use some fairly straightforward principles to protect yourself from utter financial disaster. They include:

  • Appropriately diversifying your holdings so that you don't depend too heavily on any one company or industry.
  • Ensuring your holdings show solid balance-sheet strength, such as keeping debt-to-equity ratio in check.
  • Looking for companies with both positive earnings and strong operating cash flows to back up those earnings.
  • Accepting dividends as signals of financial stability and strength, so long as those dividends are well covered by earnings and cash flows.

When you follow those principles, you wind up with companies like these:

Company

Industry

Debt-to-Equity Ratio

Net Income

Cash from
Operations

Dividend Yield

Payout Ratio

ExxonMobil
(NYSE: XOM  )

Energy

9%

$31,150

$35,994

2.4%

26%

Microsoft
(Nasdaq: MSFT  )

Information Technology

15%

$14,569

$19,037

2.1%

31%

Wal-Mart
(NYSE: WMT  )

Consumer Staples

68%

$13,393

$22,878

2.1%

30%

Johnson & Johnson
(NYSE: JNJ  )

Health Care

29%

$12,739

$15,084

3.2%

41%

McDonald's
(NYSE: MCD  )

Consumer Discretionary

83%

$4,250

$5,728

3.6%

49%

ABB
(NYSE: ABB  )

Industrials

19%

$2,467

$3,479

2.4%

43%

Chubb
(NYSE: CB  )

Insurance

27%

$1,563

$2,410

2.9%

31%

Data from Capital IQ, a division of Standard & Poor's. Dollar amounts in millions.

Even though following those investing principles won't give you an ironclad guarantee of a comfortable retirement, you'll likely still be better off than if you'd relied solely on the shaky promises of Social Security.

Get started now
At Motley Fool Rule Your Retirement, we want you to have a fighting chance at a comfortable future. But to get there, you need to start funding your nest egg now. If you join us, we can show you how to design, build, and execute a plan that will enable you to have a far more comfortable retirement than you'd get by relying on Social Security alone.

To find out how we can help you get your future in order, click here to start your no-obligation free trial. If you decide it's not for you, simply cancel within 30 days, and you won't pay a dime.

At the time of publication, Fool contributor Chuck Saletta owned shares of Microsoft and Johnson & Johnson. Microsoft and Wal-Mart are Motley Fool Inside Value selections. Johnson & Johnson is a Motley Fool Income Investor pick. ABB is a Motley Fool Global Gains recommendation. The Fool's disclosure policy fully expects to outlast Social Security's current form.


Read/Post Comments (7) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 10, 2009, at 5:02 PM, plange01 wrote:

    by this time next year there will be plenty of inflation .with the US government bankrupt and running a madoff style ponzi to operate inflation will reach record highs due to the enormous spending going on..........

  • Report this Comment On September 10, 2009, at 6:43 PM, josephazupo wrote:

    If a group of individuals pooled their money to buy a small business (say a convenience store or gas station) there would be no benefit if the business did not generate sufficient cash flow to allow them to withdraw cash from the business i.e. generate a return on their investment.

    After 27 years of investing I finally realize that stocks must be viewed in the same way. The cash available for withdrawal is the dividends paid plus stock purchased back (less monies borrowed to do so). The remainder of the cash flow is needed to sustain or grow the business (don't forget CAPEX) and is not available for withdrawal.

    While the stock market value of a company may increase over time even though it cannot pay a cash return to its investors the value is just a mirage. We need to go back to the days when dividends provided a much larger portion of the total return and managements were not incentivized by stock options to inflate the stock price.

    I have become more and more convinced that the stock and other financial markets exist so Goldman Sachs, Morgan Stanley, JPMorganChase, hedge funds et. al. can steal mony from small investors.

    I am a life long believer in capitalism but don't confuse an economic system with badly functioning financial markets.

    Joseph A. Zupo

    Atlanta, GA

  • Report this Comment On September 10, 2009, at 8:53 PM, shoemaker17 wrote:

    hmmm, if only we had death panels...

  • Report this Comment On September 10, 2009, at 9:04 PM, pedorrero wrote:

    Please, please don't use the term "trust fund". It's all an accounting gimmick. Yes, there is an "asset" (a special type of government bond). No, it's not really worth anything ... it's an asset (of SSA) that is a future liability of the U.S. Treasury. All the money was spent, long ago. What this means is that, just as the "surplus" was spent long ago, once SSA has to redeem those bonds, Treasury will need to get the new funds through taxes, borrowing, or the old standby, the printing press.

  • Report this Comment On September 11, 2009, at 10:59 AM, emferguson wrote:

    What are the odds the economy will stay stagnant until 2037? Even counting the Depression, we've never had a period like that. Before passing on the usual scaremongering about Social Security, please alert readers that the emptying of the trust fund in 2037 is pretty close to a worst case scenario. I'd like to know the effect is the income cap were removed. Would there be any danger at all of the trust fund running out? I'm guessing not. Moreover, would you recommend to retirees and near-retirees that they invest in government bonds? I assume you would. So why is it a problem to have the trust fund invested in government bonds?

    And Chuck, you can't seriously think there's a chance the government will let benefits suddenly drop 25%.

  • Report this Comment On September 11, 2009, at 10:20 PM, TMFBigFrog wrote:

    Hi emferguson,

    Absent major changes to the program, the Social Security trust fund will empty. Whether it empties in 2037 (current projection) or 2041 (previous projection -- before the meltdown) is really rather irrelevant. As I said in the article, tax rates have already quintupled from the program's origins, the income subject to the tax has more than doubled (inflation adjusted), and the retirement age is already on its way up.

    Also largely irrelevant is the impact of eliminating the cap on earnings, for three key reasons:

    #1) If the cap goes away and benefits do not rise commensurately for higher income people, Social Security becomes a welfare program, rather than a retirement program. Expect support for Social Security taxes to plummet as the program gets painted as old age welfare rather than as a retirement plan. If benefits do rise commensurately with taxes, then any benefit from lifting the cap will be short lived.

    #2) There are plenty of people in higher income brackets who have some measure of ability to set their own salaries and shift income between "salary" and "dividend income" (for example). This is especially true among small business owners, though executives at other companies also tend to have some control over the form of their compensation, as well. Since only certain forms of income are subject to Social Security tax, expect income to shift to forms not subject to the tax in the event the caps are lifted. For evidence of similar behavior happening in the past, consider the massive shift to stock options based compensation as caps were placed on the deductability of "salary" paid to executives.

    #3) At some point, it stops being worth it to do the work necessary to earn the additional dollar of income. The higher a person's marginal tax burden is, the sooner that person reaches that threshhold of "too much pain for no real gain". If more income is subject to Social Security tax, you can expect more people to simply stop being as productive, as the marginal return they receive on their time and effort is no longer worth it.

    Regarding whether or not the government will let benefits suddenly drop 25% -- I'd argue that it already did, back when it subjected Social Security payments to income taxes for people with income from other sources.

    Regards,

    -Chuck

  • Report this Comment On September 22, 2009, at 3:31 PM, jasonssandos wrote:

    Here is a website that provides free calculators to figure out when to collect and also determine how much of your social security benefits are taxable.

    http://www.socialsecuritymax.com/

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Chuck Saletta
TMFBigFrog

Chuck Saletta has been a regular Fool contributor since 2004. His investing style has been inspired by Benjamin Graham's Value Investing strategy. Chuck also can be found on the "Inside Value" discussion boards as a Home Fool.

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