Can We Count On Social Security?

A number of surveys conducted over the last few years show that a growing number of Americans are losing faith that they will receive their full Social Security benefits as promised. Predictably younger adults expect to receive no benefits at all when they retire. Although they may differ regarding the urgency of the situation, most financial and policy experts agree there is good reason to be concerned about Social Security’s financial health.

The Social Security Act was signed into law in 1935 under President Franklin D. Roosevelt. It established two national social insurance programs; old-age retirement benefits for workers in private industry and unemployment benefits for those who had lost their jobs. In large part these programs were a response to the devastating effects of the Depression which had decimated the lifetime savings and job opportunities for many older workers.

The scope of this program was broadened in subsequent years through amendments including those adding benefits for disabled workers, dependents of retired and deceased workers, and cost of living adjustments tied to the Consumer Price Index to offset the effects of inflation.

Social Security was designed to be a pay-as-you-go system, where the money raised by payroll taxes on workers is paid out to beneficiaries. Social Security benefits are funded primarily by the 12.4 percent (shared evenly by employer and employee) tax on our earnings from work. A portion of the payroll tax is used to pay current benefits, and the balance is invested in the Social Security Trust Fund which consists of government bonds earning interest to help pay future benefits.

In prior years there were more working people contributing to the system than retirees collecting benefits, generating cash flow surpluses for Social Security. As our population has aged however, the ratio of retirees to workers has increased. People are also living longer in retirement and the liability to pay more beneficiaries for longer periods is now being spread among a smaller number of workers presenting major challenges to the system.

According to figures published in the 2012 Social Security Trustees’ Report by the Congressional Budget Office (CBO) released last year, starting in 2010, Social Security began operating with a cash flow deficit. By 2021 benefit costs are expected to exceed Social Security’s tax revenues and bond income. As a result the program will need to begin selling bonds from the Trust Fund to pay benefits. In 2033, the Trust Fund will be depleted. At that point, with no bonds left, and with only payroll taxes to rely on, Social Security will only be able to pay about 75 cents on the dollar, with the shortfall growing quickly thereafter.

One excellent source that addresses the financial problems facing Social Security is The Social Security Fix-It Book written by The Center for Retirement Research at Boston College. It states “The only two ways to fix the problem are to cut benefits or increase revenues, but the longer we wait, the larger the benefit cut or tax increase needed to fix the problem”.

The researchers propose various ways that benefit cuts could be accomplished and the implications of each approach including immediate across-the-board cuts for current and future beneficiaries, raising the age we can claim benefits to more accurately reflect the trend toward longer life spans, or reducing the amount of the cost-of-living adjustments to benefits. They go on to suggest that revenues could be raised by either increasing the payroll tax above the current 12.4% tax rate, or raising the amount of each worker’s income that would be subject to the payroll tax. The second option means that higher income earners would have more of their pay subject to the tax.

Regardless of which solution or combination of solutions our policymakers adopt, the message is clear. The sooner we take action the less drastic and painful the measures will need to be.

About the author

John Spoto, CFP®

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