The Future of Social Security
Social Security benefits are one of the key sources of retirement income for most Americans so it can be quite disturbing to reach news headlines like:
“Americans will lose full Social Security benefits in 11 years” – Business Insider
“Social Security benefits may be cut by at least 20% in the next decade” – CNBC
Whether you’re currently claiming Social Security, are within striking distance of claiming, or have a few decades or more (that’s me 🙋♂️) before claiming, it is important to understand what is happening with Social Security, why the alarm bells are being raised, what can be done about it, and how it might impact you in the future.
How Social Security Works and Is Funded
Retirement Benefits
Social Security benefits are based on the earnings history of the individual. The amount of a retiree’s benefit depends on their 35 highest-earning years adjusted for inflation. Individuals can claim benefits as early as age 62, although full retirement age (FRA) varies from 66 to 67, depending on the birth year. Claiming before the FRA results in reduced benefits, while delaying benefits up to age 70 can increase them.
To learn more about the calculation, see Unraveling the Numbers: A Comprehensive Guide to Social Security Benefit Calculation – Gilbert Wealth
Once you are claiming benefits, benefits are adjusted annually for inflation. Married couples also receive a spousal benefit which can boost benefits for lower earning, or no earning, spouses when the higher earner finally claims.
Social Security does pay other benefits such as disability or supplemental income but the retirement benefit is by far the largest share of payments.
Funding Payments
Social Security is primarily funded through payroll taxes, which are 12.4% of earnings, split equally between employers and employees. Self-employed individuals pay the entire amount. Payroll taxes are deposited into the Social Security Trust Fund, which also earns interest through owning government bonds. Benefits are then paid from this trust.
If payroll taxes and interest exceeds benefit payments, the surplus will add to the Social Security Trust Fund.
If payroll taxes and interest are not enough to cover benefit payments, the deficit will be pulled from the principal Social Security Trust Fund.
Key Concept: Social Security benefits are paid from payroll taxes, interest on the Trust Fund, and principal paid from the Trust Fund.
The Trustees Report
If you’ve read the news headlines, you’ll have seen a reference to the Social Security Trustees Report. This comprehensive report is published by the Secretary of the Treasury, Secretary of Labor, Secretary of Health and Human Services, and the Commissioner of Social Security.
Basically what the report contains is a summary of the current status of the Trust Fund, a projection of future benefits that are expected to be paid, a projection of future payroll taxes to be collected, and a projection of how current benefits will be paid in the future.
The comprehensive report contains data on assumptions around future demographic changes, interest rate changes, labor and workforce estimates, life expectancies, and much more to come up with a best estimate of what the future of Social Security could look like.
You can view a summary of the Trustees Report here: Trustees Report Summary (ssa.gov)
When the money runs out...
The primary calculation that the Trustee Report focuses on and what the media is referencing is how long the Trust Fund can continue to pay 100% of current and projected benefits.
Remember that this includes payroll taxes, interest earned on the Trust Fund, and distributing the principal from the Trust Fund.
Under their current assumptions, the trustees expect to be able to pay 100% of projected benefits until the year 2033. In 2033, the Trust Fund is expected to be fully depleted which means Social Security benefits are only being covered by payroll taxes.
Based on the current assumptions, payroll taxes would only cover 79% of future benefits resulting in a 21% benefit cut!
If… nothing is done between now and 2033.
How to Fix Social Security
There are many ways to fix Social Security if our politicians can work together to come up with a viable solution. There are two realities that everyone has to come to terms with:
1) Ignoring the issue doesn’t make it go away. It makes it worse! A large trust fund generates income to pay benefits but if that trust fund is gone, the only solutions are to raise more revenue (ie taxes).
2) Fixes are going to have winners and losers, but a good plan will hopefully balance out the impact to current and future beneficiaries and not stick one or the other with the lion share of fixing it.
Options to Fix Social Security
- Only pay what is collected (most conservative): Of course, this is always an option – albeit an unlikely one in my opinion. It would be political suicide for congress to just let this happen and we would likely see a poor deal put in place if it came to this.
- Increase FICA taxes: Raising FICA taxes would increase the revenues flowing into Social Security for benefit payments. There are two ways to do this: increase the FICA tax rate and/or increase the taxable wage base:
- Increasing the FICA Tax Rate: The Trustees Report addresses this fix by calculating the rate of increase needed now to keep the Trust Fund solvent for 75 years. They estimate they would need to increase FICA taxes by 3.5% now to fix the trust fund for 75 years. That 3.5% would be split 1.75% for the employee and employer for wage income workers and born fully by self-employed individuals.
- Increasing the FICA Wage Base: In 2024, the amount of income subject to FICA is $168,600 (see Latest Tax Resources for updated limits). Income above this limit is not assessed the 12.4% FICA Tax. By increasing, or removing, this limit, more payroll taxes would be generated from higher wage income households. There have been proposals floated to keep the current limits but add in a higher restart thresh hold where income above a certain level is taxed again.
- Delay Filing Ages: Currently, the earliest you can claim benefits is age 62 while life expectancy in the US hovers around 86 for women and 84 for men for those who reach age 62. One way to fix Social Security is to push back the earliest claiming age which would have two effects. First, beneficiaries would be collecting benefits for fewer years. Second, because retirees would have social security benefits for those years, more people would work longer contributing more payroll taxes to the program.
- Increase Means Testing: Means testing is just a way to reduce benefits paid to higher income individuals. This could look like a phaseout of benefits for those whose income levels are above certain thresh holds.
- Alter Benefit Formula: When your benefits are calculated, they go through a benefit formula that measure monthly wages against bend points. Altering the formula to reduce benefits could be a way to lower payouts.
- Adjust Inflation: Social Security benefits are impacted by the National Wage Index when calculating your benefits and Consumer Price Index for Workers (CPI-W). Altering these rates to affect lower increases in the future would reduce payments and the strain on the Trust Fund.
- Reduce Spousal Benefits: Reducing or eliminating the spousal benefits would lower payments made.
- Increased Benefit Taxation: Social security can be fully non-taxable or up to 85% taxable depending on household income. While this tax goes into the general federal budget and not specifically to the Trust Fund, there could be additional taxes added to make the benefit fully taxable.
Is Social Security going away?
No, Social Security is not going anywhere. It is too important of a component of the financial security of Americans to be done away with entirely. Worst case benefits are cut by 21%. Painful for a lot of people but not gone.
Social Security plays a vital role in keeping millions out of poverty. According to the Center on Budget and Policy Priorities, about 23 million adults and children would fall below the poverty line in the U.S. without Social Security which includes nearly 17 million people 65 or older and almost 1 million children.
What should you plan for and do?
In my opinion, it won’t be just one of these that is used as a fix. It will likely be a combination of these that together will generate the necessary revenues or reduce distributions from the Trust Fund. Here are a few thoughts for how different cohorts might see an impact:
- Already Claiming or Within 5 Years of Claiming: The most likely case is that benefits will not be impacted. However, you may expect to see means testing or adjustments to the inflation formula which could cause social security benefits to lose value to inflation over time.
- 5-10 Year from Claiming: Along with the previous changes, it’s possible that the benefit formulas may be altered or those closer to 10 years away may start to see the filing ages increase. Additionally, higher FICA taxes for those final years is expected.
- 10+ Years Out: Along with the above changes, it’s possible to will begin to see the filing age pushed back (64 or 65 as the earliest) and higher FICA taxes.
- High Income: Those with high income ($400,000 per year seems to be a number politicians like), I’d expect to see additional FICA taxes and perhaps a means testing to phase out Social Security benefits to a certain point.
Also, write your representatives in Congress to demand their attention on this important issue. The sooner they act, the better for all of us.
History of Social Security
When Social Security was introduced in the 1930s, the ratio of workers per retiree was much higher than today. In 1950, the worker to retiree ratio was 16.5 workers for every retiree. By 1980, that fell to 3.2 workers for every retiree. It is now 2.9 workers for every retiree and is expected to drop to 2.8 workers by 2035.
If the average wage in the US is $59,000 and FICA taxes are 12.4%, that means each worker contributes ~$7,316 to the Trust Fund each year. However, the average social security benefit is ~$1,827 per month or $21,927 per year which requires 2.99 workers to sustain but we are short about .19 worker and that’s one of the problems.
As King Solomon stated in Ecclesiastes, there is nothing new under the sun. We’ve been here before. In 1982, the Trust Fund was projected to run out by July in the following year, 1983! Corrective action was taken in time and the Trust Fund survived without a cut in benefits through a combination of measures.