Many people hear that Social Security will run out of money in the next decade, and Social Security benefits will cease. This is not true. The Social Security trust fund will likely run out of money in the 2030’s, but ongoing taxes will support about 75% of current Social Security retirement benefits. In other words, the likely worst-case scenario for Social Security is benefits are cut by 25% in the early 2030s.
The disconnect stems from Social Security having two funding sources: the trust fund and payroll taxes.
Social Security Funding Sources
Social Security Trust Fund
The table below is from the 2022 Annual Report of the Board of Trustees for Social Security.
The top row in the “OASI” column says the Social Security trust fund had around 2.8 trillion dollars in it at the beginning of 2021. When the media claims that Social Security is going to run out of money, this is what they are referring to. All reasonable projections support that the trust fund will deplete sometime in the 2030s unless action is taken. There is a long history of why the trust fund is going to run out, but it basically boils down to Americans living a lot longer than anticipated, Americans having less children than anticipated, and the lack of political will to make an adjustment.
Payroll Taxes
However, what most scare pieces on Social Security leave out is that Social Security is also funded through payroll taxes! If you are working, check your paystub and there will be a line item for Social Security and Medicare taxes. If you are employed, your employer also pays the same amount on your behalf. If you are self-employed, you pay both parts. If you look again at the chart above, you will see that payroll tax contributions fund the majority of Social Security benefits currently! The trust fund is there to make up the shortfall between Social Security benefits owed and how much money comes in from payroll taxes. The chart below (again from the 2022 Annual Report of the Board of Trustees for Social Security) is a reasonable estimate by actuaries on how much payroll taxes the government can expect in the future.
The “cost” line in the graph represents Social Security benefits, while the “non-interest income” line represents taxes that fund Social Security payments.
The chart projects a growing gap between the cost of Social Security and taxes currently supporting it. Based on the chart above, Social Security benefits will be reduced by 20% beginning in 2035. Social Security benefits then stabilize as they cover 74% to 80% of current benefits over the next 75 years. While this is a serious issue, doomsday pronouncements of Social Security collapsing are overstated.
How much Social Security should retirees plan on receiving?
For people close to and in retirement, Social Security is a substantial income source, and often makes up around 50% of their income. Therefore, forecasting how much Social Security benefits they will receive is critical to determining how much they will be able to spend in retirement. The first step in forecasting the future of Social Security is determining what is stopping Social Security from becoming fully funded. There are numerous methods to fully fund Social Security for the next century, so the issue isn’t how to do it. The issue is agreeing upon a solution and implementing it. In other words, the issue is political will. If you knew when a solution for Social Security would be passed, and what solution it was, you would be able to accurately predict what Social Security benefits you would be entitled too. Unfortunately, accurate predictions about future political actions are difficult.
Please note that even if you knew this, you wouldn’t be able to accurately predict how much Social Security benefits you will receive. The largest determinant of this is your life expectancy (and your spouse’s if applicable). There are various other factors as well. Claiming Social Security should consider many factors such as life expectancy, the opportunity cost of investment returns, marriage status, health, the chance of future Social Security reductions, when you will stop working, etc.
Politics of Social Security
There are only three solutions to ensure full funding of Social Security:
- Increase taxes
- Decrease benefits
- A combination of 1 & 2.
All solutions for Social Security can be grouped into one of the categories above. Notice that all of these solutions involve somebody ending up with less money. Either someone’s taxes are increased, resulting in less income for them, or Social Security recipients receive less money. This is probably why no solutions for Social Security have been implemented. Politicians will alienate some part of their voters no matter what. However, the population of people who vote in the US is skewed towards people who are close to and receiving Social Security. Americans age 50+ made up over 50% of registered voters in 2020. Older Americans have higher rates of voting than younger citizens. Therefore, many politicians have extra incentive to not reduce Social Security benefits, as it could alienate their largest group of active voters.
For this reason, I believe it is likely Social Security benefits will only see a minor reduction or no reduction at all for individuals who are currently 55 years or older. The more likely scenario in my mind is increasing taxes to fund benefits in the short-term and reducing benefits in the long-term for younger citizens to help fix Social Security funding issues. Of course, I could be wrong, nothing could be done, and Social Security could face a 25% reduction in benefits for everyone. Speak with your financial professional to determine the right steps for you.
Action Steps
If you would like to be conservative in your retirement planning, you can only count on receiving 75% of the benefits that Social Security shows you are entitled to. I will cover ways to incorporate this into your Social Security claiming decision another time. On an individual level, the most important action anyone can take to ensure they receive full Social Security benefits is speaking with their federal Congresswoman / Congressmen. Let them know how important this issue is to you, and that you want to see action now. The longer a solution to Social Security is delayed, the greater the cost will be to ensure full benefits, and the harder it will be politically to pass.
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