Those approaching retirement can now buy a type of “insurance” to guard against reduced Social Security benefits.
The product — a rider on an annuity — is the first of its kind, but some experts expect similar offerings to follow as worries over the future of the entitlement program grow due to the pandemic.
“The largest unaddressed fear is the Social Security reduction,” said David Duley, founder and CEO of PlanGap, which has received regulatory approval for the new product in 44 states.
The surplus in the fund that pays out Social Security benefits will be depleted by 2031 — a year earlier than previously forecast — largely due to mass layoffs during the pandemic, according to the Congressional Budget Office. After that, the fund could pay about three-quarters of benefits for retirees, a major hit to the largest source of retirement income for most Americans.
“People are in this stage of their lives where they’re 45 and 50 and are questioning what will happen if Social Security [cuts] take place,” Duley said.
How does Social Security insurance work?
The Social Security insurance by PlanGap is an annuity where you pay a lump sum upfront and that amount grows at a fixed rate every year. When the guaranteed period is over, you can withdraw the premium or continue to grow it for another five years.
If the government mandates a qualifying reduction in Social Security benefits, you get a bonus from the annuity based on how long you’ve held it. You can withdraw these funds without penalty to cover any gaps in your retirement income.
You also have the option to delay when the payout begins, increasing the bonus amount you will receive. Interest earned is tax-deferred during the term. You pay income taxes when you make a withdrawal.
There are penalties, too.
For instance, if you withdraw prior to the age of 59 ½, you can be subject to a 10% federal income tax penalty. Starting your second year holding the annuity, you can withdraw 10% without a surrender charge. But if you withdraw more than 10% of the amount accumulated, you will have to pay that penalty.
“This isn’t casino money,” Duley said. “This is a nest egg you want to protect with our product.”
‘You can’t decide a year from now you don’t want it anymore’
A benefit of the annuity is that it currently pays a higher rate of return of 2.75% compared with other, low-risk financial products, such as certificates of deposit, which can pay under 1%.
But you’re locked in, which could be a drawback, according to Harry Bartle, executive vice president at LifeYield, a financial software company.
“I would caution that this is an annuity product, which has inherent pieces that are of a higher cost,” Bartle said, “and you can’t decide a year from now you don’t want it.”
Other avenues could provide better results, too. For instance investing in the stock market may provide higher returns.
“The risks of any financial investment is the tradeoff that some people can get a higher rate of return if they invest in equities,” Duley said. “But some people don’t have the stomach for that.”
‘Something all insurance companies will have someday’
The product comes as Americans’ concerns over retirement and Social Security have heightened. A recent study by the Nationwide Retirement Institute found that 3 in 5 adults worry now more about Social Security running out than before the pandemic.
President Donald Trump has also signaled that he would like to make the temporary payroll tax deferral he enacted in September permanent if he’s reelected. Without funding to replace the lost payroll taxes, the Social Security fund would run out by 2023, according to the chief actuary of the Social Security Administration.
Against that backdrop, financial experts expects other insurance companies will likely follow Duley’s lead.
“This is something new I haven’t seen before in the last 12 years,” Bartle said, “and I can see this as something all insurance companies will have someday.”
Michael Foguth, founder of Foguth Financial Group, agreed.
“I foresee this becoming a reality,” Foguth said, “because I see so many people already doing something just like it with their own money.”