What’s Wrong With Social Security?

RetirementThe Social Security Board of Trustees recently released its annual report on the status of the programs it oversees, which currently provide benefits to around 62 million Americans.

By and large, the numbers were consistent with where they were a year earlier.

Near term, the Social Security system is fine.

Longer term, changes need to be made to Social Security to maintain its viability given expected demographic changes.

The good news is the numbers may not be as dire as the mainstream media has led some to believe, and relatively modest changes could ensure Social Security will continue to provide benefits to tens of millions of Americans for many decades to come.

The bad news is the necessary changes will likely require copious amounts of common sense and bipartisan collaboration, both of which seem in short supply in many parts of the United States these days!

What Is Social Security?

The formal name for what is commonly called Social Security is the Old-Age, Survivors, and Disability Insurance (OASDI) program.

OASDI consists of two parts. The Old-Age and Survivors Insurance (OASI) program, which is what many of us think about when we hear “Social Security”, pays monthly benefits to retired workers, their families, and survivors of deceased workers, while the Disability Insurance (DI) program provides monthly benefits to disabled workers and their families.

To fund those benefits, the Social Security program collects payroll taxes from current workers through the Federal Insurance Contributions Act (FICA) tax and the Self Employment Contributions Act (SECA) tax. Most workers in the US pay into the Social Security system via FICA and SECA taxes, which can earn them credits for potential future OASDI benefits of their own.

Over the course of the Social Security program’s 83-year history, it has collected $20.9 trillion and paid out $18.0 trillion, leaving asset reserves of $2.9 trillion in the OASI and DI trust funds as of the end of last year.

At year-end 2017, the OASDI program was providing benefit payments to around 62 million Americans, including roughly 45 million retired workers and their dependents through OASI, six million survivors of deceased workers through OASI, and 10 million disabled workers and their dependents through DI. About 174 million people had earnings covered by Social Security and paid payroll taxes on those earnings last year.

Total OASDI expenditures last year were $953 billion, while total income was $997 billion, consisting of $911 billion in non-interest income (largely from payroll taxes) and $85 billion in interest earnings.

That’s right – the Social Security program took in more money than it paid out last year! As I mentioned earlier, the program currently has assets worth almost $3 trillion dollars, which are held in special issue U.S. Treasuries.

So What’s The Problem?

The problem is the Baby Boomer generation!

Just kidding!

The problem is demographics of the United States are changing rapidly, which will impact the Social Security program for decades to come.

The fertility rate in the U.S. fell to a record low last year, meaning there may be fewer young people paying payroll taxes when Generation X’ers like myself and Millennials look to collect our own OASI benefits in the coming decades. And more and more Baby Boomers move from paying into the system via payroll taxes to collecting Social Security retirement benefits every day.

The ratio of covered workers to OASDI beneficiaries was between 3.2 and 3.4 from 1974 through 2008, but has now dipped to 2.8. The ratio of workers to beneficiaries is expected to drop to 2.2 by 2035, when most Baby Boomers will have retired, but will continue to decline gradually even after that given the expectation of longer life spans for retirees.

The result of these demographic shifts is that Social Security’s total cost is expected to exceed its total income this year for the first time since 1982. Costs have exceeded non-interest income since 2010, but until this year, interest income had been able to make up the difference. Consequently, the $2.9 trillion in Social Security asset reserves is expected to decrease by about $2 billion this year.

Based on current law, that same pattern is expected to continue for the next couple decades. The yearly deficit between income and expenses will accelerate in the coming years as Baby Boomers continue to retire and the ratio of workers to beneficiaries continues to fall.

The Social Security Board of Trustees currently believes the reserves of the combined OASDI program will be depleted by 2034. At that time, it’s expected that continuing income to the combined trust funds from workers via FICA and SECA taxes will be sufficient to pay 79% of scheduled benefits. By 2092, the Trustees expect that continuing income will cover about 74% of program costs. For their 75-year projection period, the expected deficit is 2.84% of taxable payroll.

Although the date when the combined trust funds may be exhausted and the 75-year actuarial deficit were essentially unchanged from last year, the longer-term trend is in the wrong direction. In 2010, the Trustees estimated the Social Security trust funds would not be depleted until 2037, and that the program faced a 75-year shortfall of 1.92% of payroll.

OK, I Get That There’s a Problem With Social Security. What Does That Mean For Me?

Financial IndependenceThe retirement age for full Social Security benefits for those born in 1960 or later is 67 years old. Most Gen X’ers and all Millennials and members of Generation Z will not yet be eligible for full OASI retirement benefits in 2034, when the reserves of the combined OASDI trust funds are expected to be depleted.

This means that unless something changes, many of us currently paying into the Social Security system will not get the full benefits we’re currently scheduled to receive. As mentioned earlier, the Trustees expect that continuing income from workers will be sufficient to pay only 79% of scheduled benefits in 2034. Although people my age may not get everything we’re expecting from the program, it seems likely many of us will still receive something.

Something is Better Than Nothing, But I Want More!

I do too!

But we need to keep in mind the old economic adage that there’s no such thing as a free lunch!

The Social Security Board of Trustees notes there are three primary ways to address the program’s looming financial shortfall:

  1. Raising taxes – increasing the tax rate for the Social Security program or the maximum level of earnings subject to Social Security taxation ($128,400 in 2018). As mentioned earlier, 75-year solvency could be achieved with an immediate 2.84% increase to Social Security payroll taxes.
  2. Reducing benefits – increasing the retirement age to receive full benefits, or lowering benefits for current and/or future recipients of Social Security. 75-year solvency could be achieved today with a 17% cut to benefits, both for current and future participants in the program.
  3. A combination of 1 and 2.

Any option that will truly fix the coming actuarial deficit will require either higher taxes today, lower benefits in the future, or some combination of the two.

Summary of “What’s Wrong With Social Security?”

  • The Social Security system provides retirement and disability benefits to about 62 million Americans. About 174 million people paid taxes on earnings to fund the program last year.
  • The Social Security system currently has asset reserves worth about $2.9 trillion.
  • Because of expected demographic changes in the coming years, those asset reserves are likely to be depleted by 2034, at which time the combined OASDI program could pay about 79% of current projected benefits from ongoing payroll taxes.
  • To address the coming financial shortfall, changes will need to be made to the Social Security system, most likely via higher taxes and/or lower future benefits. The longer politicians wait to take action, the more dramatic the future changes will need to be.

Next week, I’ll take a look at some potential solutions that could close the anticipated funding gap in the Social Security program.

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