We often receive comments from clients that Social Security is running out of money and will go broke in 2034. You’ve probably heard the same thing from news articles or around the water cooler.
Inevitably, this leads to concern that Social Security payments will stop, or will not be around when you retire, creating significant misunderstanding and irrational fear about the solvency of the system.
First, the good news upfront; Social Security is not going broke!
Now, for the bad news; without Congressional intervention, and after 2035 (originally projected for 2034 – I will cover this further in the article), Social Security is projected to payout only 83% of current benefits.
Current Sources of Social Security Payments
To explain the projected shortfall, it is first necessary to explain that Social Security payments currently come from two sources -- payroll Federal Insurance Contributions Act (FICA) taxes and an existing Trust Fund.
- FICA taxes, the Social Security portion is comprised of 6.2% tax on wages paid by the employee, and an additional 6.2% of taxes on wages paid by the employer, for a total contribution of 12.4% of wages. It is important to note, only wages up to the Social Security wage base ($168,600 for 2024) are withheld for Social Security taxes; and,
- The Trust Fund, comprised of excess taxes, brought in during previous years when the collected FICA taxes exceeded the amount of benefit payments paid.
The Trust Fund is a direct result of the surplus caused by the significant contributions of workers from the baby boomer generation when incoming FICA tax revenues exceeded benefits paid out to Social Security eligible retirees.
However, two distinct factors have occurred since the excess FICA taxes collected resulted in the creation of the Trust fund:
- As individuals from the baby boomer generation retired and drew Social Security, a greater than projected number of recipients have exceeded original life expectancy figures (resulting in a greater amount of benefits paid out than anticipated)
- Less workers now pay into the system as a direct result of lower birthrates (i.e., less workers entering the workforce)
The consequence is that beginning in 2021, FICA taxes became insufficient to payout projected benefits on its own and the current Trust Fund started to be used to ensure 100% of benefits are paid.
At the start of 2024, projections indicated there are enough reserves in the trust fund, along with projected FICA tax revenues, for the system to continue to pay 100% of promised benefits through the end of 2034.
Subsequently, and once the trust fund is eliminated and nothing is done to reform the system, projected income revenues (FICA taxes) will be sufficient to cover initially about 83% of promised benefits, a phenomenon the Social Security Administration refers to as, “A Benefit Reduction Event”.
Benefit Reduction Event Pushed Off From 2034 to 2035
In May of 2024, the independent actuary of the Social Security Trust Fund released its annual report on the financial status of the health of the Social Security Trust Funds.
As the result of a stronger than forecasted economy, as well as greater than expected job and wage growth, and low unemployment, the board revised its forecast of when the Trust Fund will be exhausted by one year, through 2035.
Here is a link to a short clip from Martin O’Mally, Commissioner of Social Security, addressing the trustee report: https://blog.ssa.gov/social-security-2024-trustees-report/
Mixed Feelings on Benefit Reduction Event Pushed to 2035
While this might seem like good news, it simply kicks the can and allows Congress to drag their feet another year before taking action to fix the impending Benefit Reduction Event. Besides, a weaker economy, little to no job growth and high unemployment can easily cause the Benefit Reduction Event forecast to revert back to 2034 or sooner. Second, and more importantly, since the Trust Fund will eventually run out in its current condition; without Congressional action, benefits will be cut to approximately 83% of current or promised benefits.
So, what would a reduction look like? Assuming a retiree in 2036 is collecting $3,000 per month, and his spouse receives $1,500 per month for a total $4,500 monthly benefit. In 2036, without intervention from Congress, this benefit would be reduced by 17%, and this couple would now receive $3,735 per month – a $9,000 per year reduction in retirement income. While some retirees with sufficient savings may not be impacted, for a vast majority of retirees who rely on Social Security benefits for their living expenses, a 17% reduction in their Social Security paycheck may prove catastrophic.
Addressing the Shortfall
In reality, we believe Congress will likely take action to protect benefits; however, when they take corrective action is another topic. Without question, hard choices and decisions will have to be made prior to 2035 to maintain paying 100% of Social Security benefits. Unfortunately, and as history has shown, Congress often waits until the last minute to take action to fix difficult and complex issues. Here are two of the most likely fixes Congress is considering:
Option 1 - Increase the maximum earnings subject to Social Security tax.
The 2024 Social Security wage base is $168,600; meaning income up to, but not over $168,600 of one’s individual wages, are subject to FICA taxes. In an effort to raise Social Security revenues, Congress may look to additionally tax wages over $400k (under this proposal, wages from $168,601 to $399,999 would not be taxed for Social Security). Next, Congress may look to remove the wage base entirely and make all wages taxable with no grace amounts of earnings not taxed or limit of the amount of income taxed.
The counterargument to this proposal is it unfairly taxes high earners, above the current maximum wage base which closely equates to paying enough into the system to receive the maximum Social Security benefit in retirement.
If the wage base limit is lifted, high earners will pay more into Social Security, yet not benefit from an increase in their benefit limit. Rather, the additional FICA tax revenue would in essence replace some of the purpose of the Trust Fund.
Option 2 - Raise the Full Retirement Age (FRA), currently age 67.
This is not a new concept, the FRA (one’s baseline benefit) upon inception of Social Security was 65. In 1983, the last time major changes were made to preserve 100% payment of Social Security benefits, the FRA was incrementally raised from 65 to 67. It is important to note when this change was enacted, retirees who were already receiving benefits, and those nearing retirement age, were not affected by this retirement age increase.
In fact, this change was phased in over a 33-year period, and at the time the legislation was passed in 1983, those affected by the increase were in their mid-forties or younger, thus affording them ample opportunity to prepare for this change.
In the end, slowly raising the FRA to coincide with increases in longevity, as well as increasing the wage base in some way, may be the most realistic options Congress implements.
Other unlikely options which Congress may consider include:
Unlikely Option 1 - Decrease the amount of benefits, and/or develop some type of means testing where individuals with sufficient retirement assets would not receive Social Security.
First, decreasing the amount of benefits is unlikely due to the sizable portion of the population who rely on Social Security to meet their living needs. Reducing this payment would inevitably result in fiscal hardship for this group to meet their basic needs, further exacerbating the need for government subsistence. Next, means testing is also unlikely, as who should and should not receive payments would be tricky.
Part of the national support for Social Security is all workers (who work ‘on the books’ and who are not exempt from paying FICA taxes) pay into the system, and all of these workers benefit as well, thus creating a win for all who participate. Alienating a segment of the population who pay into the system but are not eligible to receive benefits because they saved diligently seems unjust.
Unlikely Option 2 - Limit COLA payments.
Social Security payments increase each year based on an index which closely resembles true annual inflation. An annual increase which does not keep pace with inflation would result in benefits losing purchasing power, resulting in income shortfalls for retirees who will rely on these benefits.
Once again, highly unlikely as about half of retirees rely on Social Security for at least one-half of their living needs in retirement. If these retirees cannot meet their basic living needs, it would result in increased reliance on assistance from other governmental social programs, thus violating one of the original tenants of Social Security to decrease reliance on other government social programs.
In conclusion, Social Security is not going broke. However, Congress will need to implement changes in order to ensure 100% of benefits are paid in future years. Inevitably, we believe changes will be made, but unfortunately Congress may wait until the 11th hour to do so.
To view ideas and updates on proposals to address potential shortfall issues, visit: actuary.org or www.ssa.gov/oact/solvency