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Will Social Security be available when I retire?

Will Social Security be available when I retire?

Many Americans worry that the social security trust fund will run out of money soon and that they won’t receive their expected benefits when they retire. Americans also are concerned that benefits will be dramatically reduced in the future, or that the full retirement age will be increased substantially. However, I strongly believe that social security will exist in its present form for many years to come. In this post we’ll explain how Social Security works, the major reasons why I expect social security to continue for a long time and some simple changes that could be legislated to fix the funding gap. Additionally, we’ll discuss how you can use this information to make your retirement planning more robust.

Social Security Basics

The Social Security Administration (SSA) is an independent agency of the U.S. Federal Government. SSA oversees two major programs: Old age and Survivors insurance (OASI), which is what you think of when you hear Social Security, and the Disability Insurance (DI) program which pays benefits to you and family members based on how much you paid into the social security system. These programs were created in the aftermath of the Great Depression, as many Americans lost their retirement savings. FDR signed the Social Security Act into law in 1935; taxes were first collected in 1937 and the first payment was made in 1940. To fund OASI and DI programs, a flat tax of 12.4% is levied on the first $137,700 an individual earns for 2020. Employees pay 6.2% and employers also pay 6.2%. Self-employed individuals pay the full 12.4% tax. Collected taxes are then placed in the social security trust fund and are used to pay benefits. Payments are made to recipients when they reach a certain age, with the Full Retirement Age ranging from 65 if you were born in 1937 to 67 if you are born in 1960 and later. Additionally, you can opt to wait until age 70 to receive a higher annual benefit. The actual benefit you receive is based on the number of years you have worked as well as the amount of taxes you paid into the system. The OASI program provided benefits to roughly 64 million Americans in 2019: 48 million retired workers and dependents, 6 million survivors of deceased workers, and 10 million disabled workers and dependents.

Full Retirement Age

Financial challenges for SSA

Financial Challenges of OASI and DI are well known due to the large number of baby boomers retiring as well as the fact that declining birth rates mean fewer workers will be paying into the program going forward. The below chart shows key dates for the OASI and DI programs. For OASI benefits paid exceeded taxes collected excluding interest in 2010. In addition, benefits paid for the program are expected to exceed total income in 2021 and trust fund reserves are expected to be depleted in 2034. Once the fund reserves are depleted, the current level of taxes is expected to pay 76% of the scheduled benefits for OASI. The DI program is in better financial shape, but is a much smaller program, with full benefits expected to be paid until 2065 when DI’s reserves will be depleted, and the current level of taxes will be able to pay 92% of scheduled benefits. These data are based on a number of assumptions by the SSA which include: GDP growth, population growth, CPI, and real interest rates among others. Of course, these are just assumptions and actual results could vary substantially. Every year the SSA puts a report detailing the status of these programs and changes to the expected funding status over time. While these financial challenges have been well known for decades, politicians continue to ignore the problem given the number of years until the trust fund reserves are depleted.

Key SSA Dates

Source: Social Security Administration 2020 Status Report

Current Social Security trust balance

At Year-end 2019, OASI and DI had reserves of $2.9 trillion, the same amount as of year-end 2018. The below chart shows the reserves for each program, the income received and the costs, which are the payouts made by SSA. While the reserves seem to be substantial, you can see that taxes received are roughly the same as the costs paid out for these programs. As shown below, Social Security expenses are expected to increase as the U.S. population ages. OASI and DI are expected to increase from 4% of GDP in 2010 to about 5% currently and 6% in 2035.

SSA 2019 Funding Status

Source: Social Security Administration 2020 Status Report

Why I believe Social Security will still exist in its current form

Legally challenging to eliminate. Social Security was created through an act of congress, and as such would require legislation to eliminate. Importantly, OASI and DI represent a social inter-generational promise between Americans. Eliminating the programs and breaking that promise would have substantial negative implications for the country. It would also likely hurt the credit rating of the United States which would ultimately increasing the country’s borrowing costs over time.

There are many solutions to improving Social Security funding. Solutions for improving Social Security’s funding largely fall into two categories, increasing revenue through tax increases or reducing expenses by reducing the amount of benefits paid out. Privatizing social security is another option which in theory could increase the funding available to pay benefits. Of course, some combination of these options could also be implemented to solve Social Security’s funding gap.

  • Increase or eliminate the earnings cap. Currently the first $137,700 you make are taxed for SSA, with 6.2% paid by employee, 6.2% paid by employer. For self-employed pay the full 12.4%. However, congress raises the income limit every year and could ultimately increase the cap or eliminate the earnings cap entirely. The earnings cap for Medicare was eliminated in 1994, so there is precedent for this option. Depending on how much the earnings cap is increased or eliminated, this option could eliminate most of the funding gap.
  • Increase the payroll tax rate for OASI/DI. Currently the tax rate is 12.4% as noted above, but this tax rate has been increased over time from only 2% in 1935-1947. Congress could authorize an increase in the tax rate itself to improve the program’s funding. It is estimated that a 0.6% increase in the tax rate would close about 20% of the current funding gap and a 2.4% increase in the tax rate would close nearly 2/3's of the funding gap.
  • Means test for benefits. This solution would involve only paying benefits if the recipient’s income or assets were under a certain level. There are many examples of means tested programs, including Medicaid, which pays for healthcare costs for Americans based on their income.
  • Raise the full retirement age. The way the program works now is to pay a full benefit at your retirement age, based on what year you were born. Additionally, you can increase your annual benefit by waiting until age 70 to receive benefits. Ultimately, congress could authorize SSA to raise the full retirement age. While this would be politically unpopular, it has happened in the past and as the population ages there is some justification for this solution.
  • Reduce cost of living adjustments. Social security benefits are currently increased based on CPI-E, which is Consumer Price Index-Elderly. By reducing the cost of living adjustments, this would keep the full retirement age the same, but effectively lower the benefits paid out to beneficiaries.
  • Privatize Social Security. Currently the Social Security Trust Fund can only legally invest on special-interest government bonds which earn an exceptionally low rate of return. One option would be to revise what the Social Security Trust could invest in and include public equities, corporate bonds, and other asset classes with higher expected returns than the special-interest government bonds that the Trust currently invests in. While there was not much support for George W. Bush’s 2005 plan to privatize social security, this is another solution to be considered.

OASI and DI have been amended substantially over time. Numerous amendments have been made to social security over time including: increasing the tax rate from 2% in 1935-1947 to 12.4% today, increasing the earnings base over time and increasing the age of eligibility for full retirement benefits. Additionally, changes have been made over time in terms of how dependents can qualify for benefits, what cost of living adjustments are made, and even what major employment categories are included. As a result, the OASI and DI look much differently today than when the program was enacted in 1935.

Seniors vote in highest numbers. As shown below the percentage of Americans aged 65 and older will continue to increase from 15% in 2014 to 21% in 2030. As a result, there will be even large percentage of Americans voting who will be receiving social security benefits. Additionally, Americans age 60 and above have the highest voting turnout rates, shown in the 2nd chart below. I have a hard time believing that a large number of seniors will vote to substantially reduce social security benefits, against their own interests. Additionally, the average age of Representatives was 58 as of 2018 and the average age of a senator was 62 as of 2018.

U.S. Population Age Distribution

Source: https://www.census.gov/content/dam/Census/library/publications/2015/demo/p25-1143.pdf

Voter turnout by age

Source: http://www.electproject.org/home/voter-turnout/demographics

How to use this information for retirement planning

In terms of using this information for retirement planning, I recommend modeling out a few different scenarios for social security. These would include taking full social security benefits at a later age, as well as reducing your expected benefits by 25-30%. I don’t believe you will need to fund 100% of your retirement yourself, but it is also important to make sure that your retirement planning is robust if the full retirement age is raised or benefits are reduced. The SSA provides several tools you can use to calculate your expected benefits:a quick calculator, and a comprehensive calculator.

Conclusion

To summarize, I believe Social Security benefits will be available long into the future as the program has run into challenges before and been modified to improve its financial status. In addition, there are numerous solutions to improve Social Security’s funding. Furthermore, seniors continue to be one of the largest voting blocks in the U.S. and the percentage of the population age 65 and above will continue to increase going forward. It is difficult to see this age group voting to dismantle the program. Finally, the program was created by an act of congress, and it would take additional legislation to eliminate the program. As a result, I do believe it is reasonable to assume some level of social security benefits when you are planning for retirement. To be conservative, you may want to assume that you receive benefits at an older age, or that benefits are partially reduced relative to their current levels

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