The future of Social Security in the United States is hotly contested. Both current and future retirees are concerned that the retirement income they’ve been promised won’t be there and should be excluded from financial plans. We’re going to examine the current state of affairs as well as some of the popular notions of Social Security reform. Will the likely changes, if they occur, be enough to secure the future of Social Security?
Social Security brings in revenue in the form of taxes on wage earners. Employees and employers each contribute 6.2 percent of employee wages, for a total of 12.4 percent. This is the primary source of funding for Social Security’s main expense, the monthly income benefit paid to retirees. When revenues exceed expenses, as has been the case generally for many years, the surplus is invested in U.S. Treasury securities, collectively known as the Social Security Trust Fund. Currently that Trust Fund stands at $2,892 billion. That portfolio of treasury securities also generates interest, which serves as a secondary source of revenue for the Social Security system. Total revenue for the Social Security system in 2017 was $997 billion, of which $874 billion came from taxes on wages, $38 billion from benefit taxes, and $85 billion from interest on the Trust Fund.
While the numbers sound promising, the problem generally lies in the population’s shifting demographic. Baby boomers are beginning to retire, and this combined with progressively longer lifespans means the ratio of workers to retirees is declining.,. As of 2018, there will no longer be an annual surplus, but rather an annual deficit as the amount paid in benefits exceeds the revenues for Social Security, with the shortfall currently being covered by interest on the Trust Fund. The deficit is projected to grow year by year if the current system remains unchanged, with the Trust Fund facing complete depletion by 2034.. At that point, the projected revenues will be about 79 percent of the total expenses of the system and Social Security would NOT be able to fulfill its stated obligation.
(Chart 1 shows Trust Fund total income exceeding Trust Fund expenditures from 1984 through 2017, generating annual surpluses. Beginning in 2018, total income is projected to be less than expenditures, generating annual deficits (shown as negative surpluses).
Now, this would be a pretty disastrous situation for many Americans who rely on their Social Security checks, thus causing the current widespread fear. However, contrary to popular misconceptions, this would not actually be the end of the Social Security system because the majority of its funding would still be covered by revenue from those still working. It would mean that as of 2034, either all benefits would be cut by approximately 21% or some people would not receive those benefits and others would receive more than 79% of their stated benefits.
Let’s examine some of the popular proposals to remediate the failing Social Security System.
From a financial planning perspective, only one of the solutions above would cause an elimination of benefits, which would only potentially apply to a small number of clients (approximately 61 million receive Social Security, but only 1 percent are top earners, which would result in about 600,000 eliminated beneficiaries). To generate $250,000 in taxable income, a retired married couple would have to have dividend and interest income on a portfolio of roughly $10 million [2.50% x $10 million = $250,000) or have a traditional IRA required minimum distribution (RMD) on a portfolio of roughly $5 million (250k/27.4 yrs = $9124.09 RMD). Since this cap has historically increased with inflation, those portfolio sizes represent today’s dollars for general magnitude.
For most of America, the absolute worst case regarding Social Security would be if nothing is done and they received only 79 percent (decreasing to 73 percent over 75 years) of their promised benefit. Since there are a number of seemingly reasonable alternatives to this scenario, it appears that situation is unlikely. However, clients looking to be extremely conservative in their planning could choose to plan for only 79 percent of their stated benefit. It seems clear that removing Social Security altogether from the plan would be too conservative for all but the wealthiest Americans.
As with many solutions, the most likely event here may be a combination of adjustments. Increasing the retirement age gradually on today’s younger workers may be the most palatable. The more delayed this change is, the more likely other supplemental changes may also have to be included, such as an increased cap on wages taxed or an actual increase in the tax rate itself. Since means testing doesn’t actually cover a large portion of the shortfall, it may be less likely to be part of the equation.
The bottom line is that the Social Security system may be in dire need of reform, but it’s not going away.
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31 Max, Sarah. “Will Social Security Really Run Out of Money? | Money.” Time. March 21, 2016. Accessed August 01, 2018. http://time.com/money/4213065/will-social-security-run-out-money/.