Here’s what to keep in mind when planning your future around Social Security benefits.
When the Social Security Administration (SSA) was founded in 1935 following the Great Depression, it was meant to be a source of financial security for older Americans. Yet, a common concern today among Americans, especially the younger demographic, is that Social Security might not be around when they reach retirement age. This is an especially valid concern as ongoing trends seem to suggest that the viability of Social Security is in danger.[i]
Taking this into consideration, let’s explore the present and forecasted financial state of Social Security, what the issues are, and what solutions are available to remedy the situation. It’s impossible to predict exactly what lies ahead, but this information can paint a useful picture of where Social Security is headed.
The financial state of Social Security
The Social Security program’s expenditures include all retirement, survivor, and disability benefits.
In 2017 the program had a surplus, in 2018, what seemed like a sizable cash reserve at 2.9 trillion. While the reserve appears steady, the 2021 SSA report states that the program’s finances have negatively impacted through the lack of payroll taxes paid during the pandemic and short-lived recession of 2020.[ii]
According to the SSA report, The OASI Trust Fund, which pays retirement and survivors benefits, will be able to pay scheduled benefits on a timely basis until 2033, one year earlier than reported last year. At that time, the fund’s reserves will become depleted and continuing tax income will be sufficient to pay 76 percent of scheduled benefits.[iii]
For now, however, Social Security’s reserves are financially stable. Those who are receiving a Social Security benefit or expecting one soon – can most likely count on it. The question is, for how long? While following internet rabbit holes such as the popular rumor that the government “raided” Social Security’s reserves, and therefore, there are none left is probably bad practice. However, this SSA report does seem to suggest is that younger Americans might find themselves in trouble if they don’t start planning now.[iv]
A downward spiral to be expected
Future deficits in Social Security were already being forecasted in 2018, however nobody was prepared for the monumental impact the pandemic and 2020 recession had on employment, earnings, interest rates, and GDP. Here’s a glimpse at the revenue and expenditures of Social Security, or OASDI, based on the Social Security trustees’ intermediate assumptions.
|Year||OASDI Income ($Billions)||OASDI Expenditures ($Billions)||Deficit ($Billions) — Intermediate Assumptions|
DATA SOURCE: 2018 SOCIAL SECURITY TRUSTEES REPORT. [v]
Deficits were already expanding quickly pre-pandemic with the drop to only 76% of scheduled benefits in 2034.[vi] Now, with that year being 2033, Social Security will have to extensively tap into their reserves. In only the next 11 years, payouts from Social Security will exceed incoming payroll taxes and investment earnings by around $3 trillion.
While this might sound alarming, it’s important to keep in mind that even if no changes to Social Security are made now, they will still be able to pay more than three-fourths of benefits post 2033. Yet, this is far from ideal, and we believe the best outcome would be for the SSA to act now to prevent this deficit. We feel the reality is that unless extensive changes are made, cuts will become necessary by 2033. But how realistic and attainable are these changes?
“Why is Social Security’s financial situation projected to deteriorate so quickly?” is a legitimate question. Despite the precarious effects of the pandemic and 2020 recession, Social Security is after all the most important retirement program in one of the most powerful countries in the world. So, how does the program go from over $3 trillion in reserves and yearly surpluses to large deficits?
Longevity and mass retirement by the Baby Boomers and Gen X generations[vii] are two major issues that Social Security faces today. This leaves the Millennial and Gen Z generations holding the shorter end of the stick if no changes are made. Let’s take a look at the issues of longevity and mass retirement separately.
With advancements in medicine and an overall healthier lifestyle, Americans are enjoying longer lives. Therefore, life expectancy is improving dramatically. This fact, though generally a positive one, is having a major impact on Social Security. For example, the average 62-year-old man in 2015 might expect to live another 20 years. Little over a decade ago, a 62-year-old man’s life expectancy was 18.9 years. This means that in comparison to the year 2008, a man who is 62 and filling for benefits today can expect to receive them for over a year longer. For women, the trend is even slightly higher since they tend to live longer on average.
|Age/Gender||Additional Life Expectancy in 2005||Additional Life Expectancy in 2015||Difference|
|62-Year-Old Male||18.9 years||20.0 years||1.1 years|
|62-Year-Old Female||21.9 years||22.8 years||0.9 years|
|65-Year-Old Male||16.7 years||17.8 years||1.1 years|
|65-Year-Old Female||19.5 years||20.4 years||0.9 years|
|70-Year-Old Male||13.3 years||14.3 years||1.0 year|
|70-Year-Old Female||15.7 years||16.4 years||0.7 years|
DATA SOURCE: SSA ACTUARIAL TABLES. ALL FIGURES ARE ROUNDED TO THE NEAREST TENTH.
With 76 million births in the United States from 1946 to 1964, the Baby Boomer generation had a significant impact on the economy over the course of their lives. Of the 76 million Baby Boomers born, there are still about 65 million living today. Many Baby Boomers are already retired and collecting benefits. The youngest of the generation, for example, those born in 1965, will reach retirement age in approximately 8 years.[viii]
To put this in perspective, more people will be leaving the workforce than entering it since subsequent generations (e.g., Gen X, Millennials, and Gen Z) had a much lower birth rate than Baby Boomers. The implications are that there will be far less individuals contributing to Social Security than needed to support the program, thereby forcing Social Security to tap into its reserves.
How can Social Security fix this problem?
The most realistic alternatives proposed by SSA include increasing payroll taxes, raising the wage limit to increase tax revenue, raising the minimum retirement age from 62, or benefit cuts.[ix] Social Security’s funding gap is approximately 13.5 trillion (in present value) over the next 70 years. SSA suggests that a payroll tax increase of 2.78% can close the funding gap over this period of time. However, many employers and employees are hesitant because this means they would have to split the increased cost of payroll taxes. 2.78% might not sound like a whole lot, but to put this in perspective, this means a 1.39% tax increase on up to $128,400 of earned income for every American.[x]
An alternative solution would be to either raise the taxable income cap or do away with it entirely. For instance, making all earned income subject to Social Security tax. A study by the National Academy of Social Insurance suggests that this would remedy the 76% funding gap. However, this could have a significant impact on students, new entrepreneurs, independent contractors, self-employed individuals, part-time workers, or anyone who does not fit the traditional work situation. These types of work are especially on the rise after the pandemic and 2020 recession. Still, if people continue to push back against payroll tax increases, it will most likely result in benefit cuts. Though not ideal, they’re both solutions to the problem.[xi]
A combination of these two options is likely to occur
We believe the most likely Social Security reform proposal would comprise a combination of these benefit-cutting and tax-raising measures. Furthermore, the solutions would most likely be phased in over time, similar to how the current increase in the full retirement age is being phased in. To put it another way, we’re unlikely to see a large tax hike or a benefit elimination in the near future.
The most popular reform proposal, according to the National Academy of Social Insurance, is to do away with the taxable wage cap over a 10-year phase-in period.[xii] In some cases, this is already occurring. For example, individuals who sell on eBay, Etsy, and the like, now have to pay taxes even if their sales only amount to supplemental income. Another suggestion by the National Academy of Social Insurance is to gradually hike the payroll tax by 1% for both employers and employees. This combination would not only close the funding shortfall, but it would also allow for an increase in the COLA calculation technique and the minimum Social Security payment level.
Alternative ways to fix Social Security include:
- Utilizing estate tax revenue to help fund Social Security (leading to potential federal deficits).
- Privatization of Social Security (invested in private retirement accounts).
- A one-time buyout for wealthy individuals (a one time cash payments for those who don’t really need Social Security).
- Allowing student loan borrowers to raise their full retirement age in exchange for student loan forgiveness (it would take care of about 11% of funding gap).
If you’re retired or retiring soon, don’t worry.
Due to the gradual phase-in of any changes, we wouldn’t be concerned if you’re due to retire soon or even if you are 50 years old or older. It’s the Millennials and Gen Z generations that really need to begin planning. None of the legitimate Social Security plans include any measures that will affect current retirees or those due to retire soon. The retention of benefits for older Americans appears to be solid enough.
Finally, it’s worth mentioning that this isn’t the first time Social Security has faced a deficit. In fact, Social Security’s financial situation in the 1970s actually looked a lot like it does today. Revenue just wasn’t enough to cover benefits. While lawmakers waited until the last minute to act, the Social Security Amendments of 1983 were signed into law by President Ronald Reagan on April 20, 1983, and the reform package (benefits subject to income tax) offset the gradual increase in the full retirement age.
While this reform package didn’t solve Social Security’s financial problems for good, it did extend the trust fund depletion date from 1983 all the way through the currently projected depletion date of 2034, a 51-year extension. We can hope for it to happen again.[xiii]
Given my age, will Social Security still be around when I retire?
While we can’t be 100% sure that Social Security will be around for many generations in the future, it’s highly likely that it will. Many Americans, including different ages, income levels, and political affiliations feel Social Security is a monumental part of this country and important to preserve (without major cuts). Therefore, Social Security will most likely be around when everyone who is reading this reaches the age of eligibility. The uncertainty of the situation is how the canvas will change in the interim.
Will payroll taxes be higher or will more of high- earners’ incomes be subject to Social Security tax? Will the annual cost-of-living adjustments be calculated in a different manner? Will the benefit formula change? These are the questions that are up to lawmakers to answer sometime within the next 12 years. We can only hope it happens sooner rather than later.
Bridging the Gap
In the meantime, work with your financial advisor to identify where social security could leave gaps in your income and create a plan for how those might be filled. We feel it’s always a good idea to diversify, especially when it comes to retirement income—not only for security, but for tax purposes, as well.
At URS Advisory, we aim to keep our clients as educated on these topics as possible while helping them pick the most appropriate way to handle such situations. We hope you find this article informative and helpful, and encourage you to share it with anyone you think may benefit.
[xiii] https://www.ssa.gov/policy/docs/ssb/v46n7/v46n7p3.pdf 22 April 2022