Is Social Security Actually Running Out?
Social Security was established in 1935 to provide retirement income to the US workforce. Benefits of Social Security include retirement and disability income along with Medicare, Medicaid, and death and survivorship benefits. Social Security may begin as early as 62 or as late as 70, and benefits range based on average indexed monthly earnings. Today, 62% of retired workers rely on Social Security benefits to provide over half of their income, and almost 33% rely on Social Security to provide their entire income.1,2
What’s the Big Deal?
Many Americans depend on Social Security as a financial lifeline but the way that Social Security currently works has raised serious concerns. While today’s payments are made from current payroll contributions, it is possible that workers may not have money available for them when they retire. Inflation, early retirement, longer life expectancies, and the large Baby Boomer population contribute to the growing concern.
The concern is that if nothing is done to change the current system, the trust fund currently valued at $3 trillion in asset reserves will be drained by 2035 and benefits will disappear. In fact, a 2015 survey found that 51% of respondents predicted the program will go completely bankrupt before they would be qualified to receive benefits.1 It is predicted that after 2022, Social Security cash flow will turn from positive to negative for the first time because of the decrease of the worker to beneficiary ratio due to Baby Boomers. Luckily, this information is only part of the picture.
You Are in Luck
Social Security is likely not actually going to run out. The most important clarification is where Social Security benefits are coming from. A common misconception is that all benefits come from the Social Security Trust. In reality, the trust is used today to make up the difference between money coming in from the Federal Insurance Contributions Act (FICA) taxes, and money paid out. The trust fund accounts for less than a quarter of current benefits, meaning that if the fund runs out, benefits can still remain.
As long as workers continue to pay taxes, Social Security will not disappear. While it is probable that the trust will be depleted by 2034, a majority of benefits will still be provided. An estimated 75% of benefits will be covered by the payroll tax without the trust.
In fact, in 2016, payroll taxes accounted for $836.2 billion out of the $957.5 billion collected through Social Security.1
How Can We Fix Social Security?
Marc Goldwein, Senior Vice President and Senior Policy director for the Committee of Responsible Federal Budget recently stated, “Another year has passed with our leaders in Washington doing exactly nothing to fix Social Security. As this week’s report from the program’s trustees makes clear, inaction is costly; and time is running out to secure the program.”3
While we are headed towards decreased benefits, changes can still be made:
1. Raising the Payroll Tax
A simple option is to increase the Social Security payroll tax rate. A gradual 0.3% increase could close nearly 1/5th of the gap. Raising the payroll tax cap from the current $128,400 is a popular proposal because doing so would only affect wealthier workers, therefore potentially decreasing wage inequality as well. Another modification would be to expand compensation subject to Social Security payroll taxes to include benefits such as employer-sponsored health insurance and flexible spending accounts. This option would eliminate the discrepancy between who is receiving fringe benefits, and would give additional benefits to lower and middle income workers
2. Raising the Retirement Age
Raising the Full Retirement Age (FRA) would take into account rising life expectancies and increase available Social Security funds. However, this option would be especially damaging to the 45% of Americans currently claiming benefits starting at age 62, and raising the FRA would only make up for 30% of the 75-year shortfall.
3. The General Fund
In the past, the government has made direct transfers from the General Fund. The General Fund is the primary tax and operating fund for governmental activities used to account for revenues and expenditures which are not accounted for in other funds. For example, between 2011 and 2012, Congress lowered the payroll tax by 2% and used the General Fund to make up for the decrease in Social Security money. Congress also has used the fund to pay for extra benefit credits for active-duty military between 1957 and 2001, special age-72 benefits for people not covered in 1968, and a payroll tax credit in 1984. Since 1965, nearly $260 billion has been transferred out of the General Fund.
4. Taxation of Benefits
Taxation of benefits takes a portion of income taxes of retirees with significant incomes outside Social Security and moves the money to the Social Security Trust. The taxation of benefits has contributed $370 billion to Social Security since 1983.
5. Investing the Trust
One more strategy used to keep the trust afloat is investing trust money in Treasury bonds, which have accounted for $1.9 trillion of earnings since 1965. As the Fed continues to increase interest rates, this option looks more appealing.
If the government waits until the 2030s to act, many of these adjustments may be too late. However, Social Security is often seen as too important to risk losing. If the government implements small changes to retirement ages and benefits, increases the payroll tax, or any combination of the above, full benefits could continue for many decades to come.
What Can You Do?
Social Security’s future is in the government’s hands. To best prepare yourself, ensure that you are effectively saving for retirement and preparing yourself for the future. Consult your advisor at Heck Capital to learn more.
Authored by Michael Bogard, CFA on August 30, 2018
About the Author: Michael Bogard, CFA is a Business Development / Client Relationships Senior Associate at Heck Capital Advisors. Michael earned the right to use the Chartered Financial Analyst® (CFA®) designation after completing the program in 2018, fulfilling the work experience requirements, and gaining acceptance as a member of the CFA Institute. The Chartered Financial Analyst® (CFA®) charter gives a strong understanding of advanced investment analysis and real-world portfolio management skills. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.