Thirty-five years ago, a financial professional having an introductory discussion with a customer might ask: “Do you think you can count on Social Security still being around when you retire?” Quite often, the answer was “no.” It was common knowledge that Social Security was under-funded, and destined to go broke.
Today, the question remains relevant, because Social Security is still destined to go broke. While some alterations in the mid-1980s averted the imminent collapse of Social Security, these changes only postponed the actuarial issues that must be addressed to ensure the program stays solvent.
Social Security is a pay-as-you-go program. Annual revenues (from payroll taxes, income taxes, and interest earned on reserves held in a trust fund) are used to pay old-age and survivor benefits to eligible retirees. Even though individual workers earn credits today that determine their future retirement checks, their payroll taxes are not set aside to fund their benefits. The payroll taxes from today’s workers are used to pay for today’s retirees.
As the Baby Boomer generation ages, this influx of retirees has put Social Security at a tipping point; in several years, benefits paid have exceeded revenues collected. In the past, these deficits have been covered by accumulated reserves held in a trust fund. In their 2016 annual report, trustees for Social Security projected break-even status through 2019. But beyond this point, the imbalance between workers and retirees is expected to increase. Benefits will continually and significantly exceed revenues, resulting in a gradual decline and eventual exhaustion of all reserves by 2034. In simple terms, Social Security will be broke.
But contrary to common understanding, benefits would not stop when the Social Security trust fund is gone. At that point, Social Security would continue using its annual tax income to make reduced payments, which recipients would share on an equal basis. According to the latest trustees’ report, these revenues would be sufficient to allow the program to pay 79% of the program’s benefits. Thus, a retiree receiving $1,000/mo. from Social Security would see a reduction to $790/mo.
The Possible Fixes
Once benefit programs are established, many recipients come to consider them as permanent. Termination of a program, or austerity measures like paying three quarters of promised benefits is probably not politically feasible. Which means sometime before 2034 (and hopefully sooner than later), Congress will be compelled to take action to restore long-term solvency to Social Security. Among the possible actions:
Increase the payroll tax rate. Since everyone participates in the plan, and everyone is eligible for benefits, the easiest way to resolve the funding issue is to increase taxes on everyone. This has the downside of inflicting a proportionally greater financial burden on lower-income Americans. Increase the amount of earnings subject to payroll tax. Currently, income above $127,200 is not subject to Social Security withholding.
Some proposals would remove this ceiling and make all income subject to payroll taxes. Increase the full retirement age to 70. The current full retirement age is incrementally increasing to 67 for those born in 1960 or later. Participants are eligible to receive a pro-rated percentage of their full retirement benefit at age 62, so increasing the full retirement age would effectively decrease the percentage for those who choose to start benefits early.
Decrease cost-of-living adjustments (COLA). To keep pace with inflation, Congress has authorized regular increases in benefits based on the Consumer Price Index. COLA payments could be diminished, eliminated, or approved on a year-by-year basis.
Implement a means-test to decrease or eliminate benefits for those who have other retirement assets. Because they have other sources of retirement income, some individuals already pay income taxes on their Social Security benefits. A more stringent standard could either reduce or eliminate payments for wealthier retirees, and divert these funds to less-fortunate retirees. But this approach goes against the philosophical ideal of Social Security, where everyone contributes to the program, and everyone receives a benefit.
How to Plan for Social Security
In a way, the same question applies: “Do you think you can count on Social Security for retirement?” Today’s realistic answer is: “Yes. But how much will it be worth?”
Politicians and economists like to think the course of Social Security can be corrected by tweaking the numbers – a better economy, different tax policy, adjusted retirement ages. But at the core, Social Security has a demographics problem. There are too many retirees and not enough workers to support them. Barring some cataclysmic event, those numbers aren’t going to change.
For those who are on track with their retirement planning and saving, preparing to live without it (either because of means-testing or reduced payouts) is prudent. Social Security can then be seen as a retirement “bonus” – whatever it pays is a happy addition, extra money that can be spent and enjoyed.