Everyone has read the story that reassures today's retirees: “Your Social Security benefits aren't in trouble.”

It claims that even after the Social Security trust funds run dry in 15-20 years, the system will have enough money from pay-as-you-go tax collections to fund about 80% of promised benefits.

With a few “tweaks,” such as a 2% increase in payroll taxes and a one-year delay in normal retirement age, everything will be fine for decades to come. Or so the story goes.

There are just a couple of problems.

First, the story is built on optimistic assumptions that may need revision as soon as the next recession hits.

Second, it's probably not going to be today's retirees who decide when and how the Social Security system changes. It will be younger people – mainly millennials – who finally say they have had enough uncertainly and choose to opt out.

You can see the handwriting on the wall in the growing push to give participants in state defined-benefit (DB) pensions opt-out rights, in favor of participating in a 401(k)-like defined contribution plan.

In Nevada, Republican legislators are pushing this option with the endorsement of a leading newspaper, The Las Vegas Review-Journal. According to a recent editorial, the proposal “would simply give state workers the choice of staying in the Public Employee Retirement System (PERS) or opting out to start their own individual accounts that would afford them more control over their personal financial planning. Those who opted for the latter could not return to PERS.”

Opt-out proposals are gaining momentum because they are one of the few viable solutions to the increasingly desperate funding crisis in many public DB plans.

What is likely to happen when participants in a hugely under-funded DB plan have the ability to opt-out?

Younger people, who are farther away from retirement and more vulnerable to funding shortfalls, will opt-out in droves. Older people will stay in, hoping the system can stay solvent long enough to pay promised benefits.

However, for every young person who opts out, the system's funding becomes more rickety. Eventually, older participants will start to lose confidence and opt-out, too, further undermining DB plan solvency.

Some public DB plans have horrible funding ratios, well below 70%. But Social Security is in a cellar by itself in terms of funding adequacy. If Social Security were to use the same standards as public DB plans, its funded ratio (trust fund assets divided by the present value of future liabilities) would be less than 10%.

Once Social Security approaches pay-as-you-go status (i.e., the trust funds become empty), it will be hard to resist political pressures to give younger people an opt-out. After the first million or so younger people have chosen to opt out of Social Security, the system as we know it will be forever changed.

If your clients want to believe the good-news story about Social Security, at least try to help them plan for a world in which their retirement lifestyles don't totally depend on receiving 100% of promised Social Security benefits. One day, they may thank you for it.

Instant Insights /

The ghost of retirements future: DB plan opt-outs

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