Social Security’s Future

Answer: It’s an election year so we’ll be hearing presidential candidates’ plans to prevent Social Security from going bankrupt. The problem isn’t bankruptcy, it’s that the program faces a long-term funding shortfall that, left unaddressed, will mean a reduction in benefits for future retirees. 

Social Security is funded by payroll taxes collected from workers with money going into the Old-Age and Survivors Insurance Trust Fund. It’s a pay-as-you-go system, so as long as workers are paying payroll taxes, Social Security benefits will be paid.  

For decades, the Social Security system collected more than it paid out in benefits, building up a large reserve. In 2021, when the program’s expenses started to exceed income, Social Security began to draw from reserves to fund the difference. Reserves are expected to be depleted in about 10 years at which time benefits will be reduced by approximately 23%. If Congress takes no action, those who are now 57 years old will only receive 77% of today’s benefits at retirement age.For the average dual-income couple retiring in 2033, that’s $17,400 less. 

The problem is demographics. Life expectancy of a 65-year-old in 1940 was less than 14 years while this has increased to more than 20 years for today’s 65-year-olds with a staggering 10,000 baby boomers retiring every day. 

Meanwhile, younger generations are getting smaller, which means fewer workers paying into Social Security. In 2022, there were just 2.7 workers paying into the program for each person drawing Social Security benefits. By 2035, that number is projected to go down to 2.3. 

Also, a smaller percentage of Americans’ income is subject to Social Security’s  payroll taxes because the earnings of the highest-paid workers have grown faster than those of the average worker. In 1937, 92% of earnings were below the taxable amount. By 2020, it was just 83%. 

Politicians are under pressure to remedy the situation since sixty-seven million Americans receive Social Security payments each month. This is the main source of income for many people sixty-five and older.  

There are a few options for Congress to correct the shortfall, none of which are  particularly appealing: 

Option 1: Increase tax revenue 

The obvious solution is to raise payroll taxes. Currently, employers and employees each pay 6.2% for Social Security. Increasing that rate to 7.75% could assure solvency for 75 years. However, this solution may be unaffordable for lower-income workers. 

Another option is to add new tax sources. One possibility, floated by the American Academy of Actuaries, is to tax investment income or increase estate and gift taxes, an idea that’s likely to face resistance. 

Option 2: Reduce benefits or increase taxes for high earners 

The Social Security tax rate applies only to the first $168,600 of annual wages. If Congress removed that cap and taxed all earned income, the additional revenue would wipe out 78% of the shortfall.  

Another idea is to reduce benefits for high earners who aren’t yet eligible for Social Security, not those who are already collecting. The premise is that those people will have less need for the benefits. However, this measure alone wouldn’tbe enough to curb Social Security payments and fully address the problem. 

Option 3: Raise the retirement age 

The most popular solution is to raise the retirement age. Today, Americans can start collecting Social Security benefits at 62, but the benefits increase the longer you wait, reaching a maximum monthly payout at 70. 

The full retirement age (FRA) was sixty-five for much of the program’s existence. Today, FRA is 66 years plus two months for people born in 1955and increases gradually to sixty-seven for anyone born in 1960 or later. 

Some lawmakers support increasing FRA to seventycoordinatingwith today’s longer life expectancy. This change alone could eliminate a third of the Social Security trust fund’s 75-year deficit. However, having to work to an older age could be especially challenging for low-income Americans and people working in physically demanding jobs. 

Congress last revamped Social Security in 1983, with the program months away from not being able to pay full benefits. The Democratic House, Republican Senate and Republican President Ronald Reagan agreed to gradually raise the full retirement age from 65 to 67, which was reached in 2022. This effectively cut benefits by 13% while increasing payroll taxes.  

No easy answers 

A solution will likely be a comprise and combination of these choices: higher taxes for some, lower benefits for others and more years on the job for many. Any proposal will be a political hot potato.  

The sooner policymakers act, the more options they’ll have providing more time for pre-retireesto plan rather than facing a huge hit implementing a 25% payroll tax increase come 2034. Prompt actionalso allows lawmakers to adjust for people who’ll start receiving Social Security benefits within the next 10 years, before the reserves run dry. 

One thing’s for sure: The longer they wait, the more abrupt and painful the changes will be.Stay focused and plan accordingly.