Survey after survey shows Americans—especially young people—doubting that they will ever receive any benefit from Social Security. That is simply incorrect. In some ways, Social Security financing is more secure than other government programs since it has a dedicated source of revenue in the form of the payroll tax. At the same time, it is true that the level of future benefits is uncertain.
Here’s the scoop on Social Security finances. The program is financed essentially on a pay-as-you-go basis, with current workers paying for current retirees. Today’s labor force is growing more slowly, just as baby boomers are starting to retire. That reduces the ratio of workers to retirees from about 3:1 to 2:1, which raises the program’s costs. The growing gap between the income and cost rates means that the system is projected to run a deficit over the next 75-year period (2018 to 2092), the measure typically used to gauge Social Security’s financial health.
In the short run, the impact of the 75-year deficit is masked because of payments from Social Security’s trust fund, which resulted from reforms enacted in 1983. That trust fund is projected to run out of money in 2034 but that does not mean that Social Security is “bankrupt.” Payroll tax revenues keep rolling in and can cover about 75% of currently legislated benefits over the remainder of the projection period.
To pay full benefits over the entire projection period would require more money. Social Security’s long-run deficit is projected to equal 2.84% of covered payroll earnings. That figure means that if payroll taxes were raised immediately by 2.84 percentage points—1.42 percentage points each for the employee and the employer—the government would be able to pay the current package of benefits for everyone who reaches retirement age through 2092, with a one-year reserve at the end.
The good news is that the required increase in the payroll tax would likely cause little disruption. In 2011 and 2012, Congress temporarily cut the employee’s payroll tax by 2 percentage points; when the reduction expired in 2013, the tax went back up by 2 percentage points. Workers did not appear to rejoice with the cut or protest with the increase, and from the employee’s perspective this change was much larger than that needed to close the 75-year deficit.
The bad news is that solving the 75-year funding gap is not the end of the story. Any package that restores balance only for the next 75 years will show a deficit in the following year as the projection period picks up a year with a large negative balance. Policymakers generally advocate a solution that involves “sustainable solvency,” in which the ratio of trust fund assets to outlays is either stable or rising in the 76th year. Realistically, then, eliminating the 75-year shortfall should probably be viewed as the first step toward long-run solvency.
Some might argue for solving Social Security’s deficit problem by cutting benefits rather than by raising revenue, but I come down on the side of putting more money into the system. Three points are important here:
1. Social Security checks are not large. For new retirees who claim benefits at 66, the full retirement age, monthly benefits range from $800 for low-paid workers to about $2,800 for those who have consistently earned the maximum taxable amount. In fact, many workers claim early and receive reduced benefits.
2. Social Security benefits are already in the process of being cut as the full retirement age moves from 65 to 67 as scheduled under current law. Workers who continue to retire at 65 will receive 13% less than they would have without the increase in the retirement age. Moreover, rising Medicare premiums take an ever-increasing bite out of beneficiaries’ checks.
3. The rest of the retirement income system simply does not provide enough income to enough people to cut back on Social Security. The typical household approaching retirement (ages 55-64) with a 401(k) plan has only $135,000 in 401(k)/IRA balances, and only about half of all private sector workers are covered by any type of retirement plan.
Thus, the debate about the future of Social Security is not whether it will exist. It will definitely exist because it has a dedicated revenue stream that will cover 75% of promised benefits. Rather, the debate is about whether we want to keep the tax rate constant and cut future benefits or whether we want to raise additional revenues to finance promised levels.
While it’s not wise to rely solely on Social Security checks to fund your retirement, there’s also no reason to expect to have to do without it.
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