The future of Social Security and you

To sustain Social Security funding in the future, some changes may need to be made.

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Social Security is a mainstay of many people’s retirement. It’s been around since the late 1930s, and currently provides benefits for almost 60 million Americans. But a changing workforce, fewer workers per retiree, and certain economic factors are putting pressure on the funding of Social Security benefits. To sustain the program, changes may need to be made.

Here are the major challenges facing the program, plus some of the current reform proposals and what they might mean for you.

Funding challenges

Social Security retirement and disability benefits are funded by payroll Federal Insurance Contributions Act (FICA) taxes. In the past, the taxes collected have exceeded the benefits paid out. The excess funds are credited to the Social Security Trust Funds.1 By law, income to the Trust Funds must be invested, on a daily basis, in securities guaranteed as to both principal and interest by the Federal government. All securities held by the Trust Funds are "special issues" of the United States Treasury, and are available only to the Trust Funds.

Over the years, however, the composition of the U.S. workforce and retirement population has changed—with fewer workers supporting each retiree. Currently, fewer than three workers support each retiree, down from 50 years ago, when it was four to one. This ratio is projected to drop to two to one within the next 20 years. That, plus cost-of-living adjustments, interest rates, payroll taxes, and U.S. productivity, among others things, has left the program in a much different financial position compared with 30 years ago. In time, payroll taxes may not be enough to meet current Social Security benefit payments, and the trust fund may be needed to cover a portion of the benefit payments.

Let’s look at some dates and numbers. Every year the Board of Trustees of the Old-Age, Survivors, and Disability Insurance Program (OASDI)—Social Security in short—issue a report on the financial status of the program, including detailed projections. For example, in 2014 the Social Security actuaries estimated the shortfall at 2.88% of payroll taxes. That means that if payroll taxes were to increase by 2.88 percentage points, to 15.23%,2 the program would be sustained for the next 75 years. For comparison, back in 1983 the estimated actuarial surplus was 0.02%. 

Given current projections, Social Security may need to tap into the trust fund to cover benefit payments as soon as 2020, and the trust fund is projected to be depleted by 2033. Starting in 2034, Social Security may be able to pay out as benefits only what it collects as taxes. This means that benefits may have to be reduced. The most recent estimate for the reduction from the Social Security Board of Trustees is about 25%.3 In short, if no changes are made to the system, starting in 2034, you may collect benefits worth about 75% of what you would currently expect under the system.

Potential changes to the system

In 2015, Congress removed two popular claiming strategies, "file and suspend" and "restricted spousal benefits," in an effort to reduce the funding gap. There have been a number of other suggestions, from Congress and others, for changes to the system, which could at least partially solve the financial problem. They include changes to the full retirement age4 (the age at which you will be eligible for full benefits), changes to the inflation adjustments of benefits (known as the cost-of-living adjustment, or COLA), changes to payroll taxes, and others. The Office of The Chief Actuary of the Social Security Administration has evaluated a number of these proposals and updated them with the 2014 projections.5 Let’s look into some of these proposals in more detail.

1. Cost-of-living adjustments

Currently, benefits increase every January, based on the inflation rate over the previous year. This adjustment, or COLA, is based on the CPI-W Index, which measures the inflation experienced by workers.6 The adjustment varies from year to year. In 2016 there was no change, but in 2015 the COLA adjustment was 1.7%. Some proposals suggest a decrease in COLA. For instance, the Social Security actuaries estimate that if COLA adjustments, going forward, were to decrease by one percentage point,7 then about 57% of the financial deficit would be eliminated. Under this proposal, the 2015 increase would have been 0.7% rather than 1.7%.

A similar provision involves the use of a modified, or chained, version of the standard CPI-W index. The idea behind the modified inflation index is to better capture the increase in prices that retirees experience. If Social Security were to move away from its current index and into the “chained” one, the COLA adjustment of benefits is estimated to decrease by about 0.3 percentage points on average. The implementation of such an index could reduce the actuarial deficit by 15% to 20%.

What it could mean for you: While these potential solutions may boost the financial health of the system overall, they could have important implications for your retirement plan. If you rely heavily on Social Security as a source of retirement income, you may lose the current benefit’s purchasing power over time. To maintain the same standard of living and keep up with inflation, you may have to fill that gap with personal savings.

2. Changes in claiming ages

Another set of provisions focuses on possible changes to eligibility ages: the earliest age you can claim benefits and the full retirement age (FRA). One provision proposes an increase to the FRA.8 Starting with those born in 1961, the FRA could increase by two months every year until it reaches age 69, and then increase by one month every two years thereafter. For example, if you are currently 30 years old, you may have to wait until age 69 and 6 months to get the same benefit that you currently expect to get at age 67. The Social Security actuaries estimate this proposed change could eliminate about a third of the current 75-year shortfall.

What it could mean for you: To get your full benefit from Social Security, you may have to retire later. And if you still want to retire at 67, you may need to rely more on your own savings.

3. Changes in FICA taxes

Another approach for eliminating the 75-year deficit is to increase Social Security’s funding source, which comes in the form of payroll taxes. Currently, you and your employer each pay a 6.2% (a combined 12.4%) FICA taxes on your earnings.9 If that tax rate were to increase, Social Security’s financial position would improve. For example, one of the proposals suggests that if the payroll tax rate is increased by 0.1% each year from 2020 to 2039, then kept constant at 14.4%, the financial deficit would be reduced by about half over a 75-year period. This increase would again be split equally between you and your employer. This means that, for example, if you made $100,000 in 2020, this tax increase would reduce your monthly paycheck by about $4. The following year it would be reduced by another $4 and so on. By 2040, given the same salary, you would be paying $83 more per month in payroll taxes than you did in 2020.10

What it could mean for you: Any potential increase in payroll taxes may lower your take-home pay, which may mean a cut in spending in order to maintain the same level of savings.

Conclusion

There are a number of possible solutions to Social Security’s financial challenges. It is unclear which—if any—of these proposals may be implemented and whether there would be one big change to the legislation or a combination of small changes. Any amendments to the current system can potentially affect your retirement plan and should be taken into consideration when preparing for the future.

Learn more

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1. The funds deposited into the Trust Fund can be used by the government for other purposes. In that respect, the Trust Fund can be thought of as an accounting mechanism that tracks how much money has been deposited and the interest it earns, but there is no true cash balance on hand. Social Security has the right to withdraw the funds for its purposes, at which point the Treasury would need to provide the required liquidity.
2. The necessary tax increase is 2.83% of payroll taxes, which differs from the actuarial deficit of 2.88%. The difference is due to: 1) an estimated change in wages due to the tax increase; 2) one year’s worth of benefit payments fund reserves included in the actuarial deficit estimate.
3. From the 2014 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds.
4. Full Retirement Age is the age at which you are eligible for full benefits. If you claim benefits before that age, your monthly benefit amount would be decreased, while if you claim after that age, the benefit would be increased. Your Full Retirement Age is based on your year of birth and ranges from 65 to 67. (See your full retirement age)
5. Sell a full list and detailed descriptions of the provisions.
6. COLA is estimated as the percentage change in the average Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) between the third quarter in the current year and the third quarter in the previous year.
7. This particular provision also includes a floor for the COLA of 0%. This means that nominal benefits cannot decrease.
8. The FRA is 67 for people born in 1960 or after.
9. The 6.2% tax rate represents a 5.3% retirement insurance tax and 0.9% disability insurance tax and applies to earnings up to $118,500 (in 2015).
10. The 0.1% tax increase would be split between the employee and the employer. This means the taxes the employee pays directly would increase by 0.05%. For a $100,000 salary this corresponds to $50 increase in annual taxes, or roughly $4 per month. The $4 increase in taxes is equivalent to a $4 reduction in net salary.
Guidance provided by Fidelity through the Planning & Guidance Center is educational in nature, is not individualized, and is not intended to serve as the primary basis for your investment or tax-planning decisions.
IMPORTANT: The projections or other information generated by Fidelity’s Planning & Guidance Center Retirement Analysis regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary with each use and over time.
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