If you dig into the studies and literature on the state of retirement in America, you're confronted with a disturbing reality: While many Americans don't believe they can rely on Social Security to fund their retirement, they're doing little to make up for the anticipated deficit.
According to the latest report from the committee in charge of the Social Security trust fund (I'm referring here and below to the Old-Age and Survivors Insurance Trust Fund), its coffers will be depleted sometime between 2029 and 2059. Meanwhile, due to the rapid disappearance of pension plans, more Americans than ever are using the government-administered safety net as their primary source of retirement income. Presently, almost a quarter of married couples and nearly half of unmarried persons look to their monthly benefit checks for 90% or more of their retirement income.
While the magnitude of this problem can't be denied, it's also a mistake to dismiss the likelihood of a solution. This isn't the first time the Social Security system has faced the threat of insolvency. In 1983, the last time this issue was addressed -- an effort led by Alan Greenspan, who would soon become chairman of the Federal Reserve -- the remedy yielded three decades of annual surpluses and a current trust fund balance of $2.7 trillion.
The historical roots of the coming Social Security crisis
Because the Social Security system was introduced during the Great Depression, it's often assumed the program was established to help elderly Americans who had been devastated by the crisis. But this is only partially true.
The precedent for a social safety net for retired workers dates to the 1880s in Germany, which had built a social insurance program that provided its citizens with sickness, maternity, and old-age benefits. Because the system came to be associated with Germany's rise and rapid industrialization, a chorus of academics and policymakers in the United States started calling for a similar program. It wasn't until the Great Depression, however, that these ideas achieved a critical mass of support.
As then-Secretary of Labor Frances Perkins observed years later:
I've always said, and I still think we have to admit, that no matter how much fine reasoning there was about the old-age insurance system and the unemployment insurance prospects -- no matter how many people were studying it, or how many committees had ideas on the subject, or how many college professors had written theses on the subject -- and there were an awful lot of them -- the real roots of the Social Security Act were in the Great Depression of 1929. Nothing else would have bumped the American people into a social security system except something so shocking, so terrifying, as that depression.
But far from being reduced after the Great Depression came to an end, the Social Security system was expanded at regular intervals over the following four decades.
Survivors' and dependents' benefits were established in 1939. The first of many ad hoc cost-of-living adjustments were implemented during the 1950s, the same decade when farm and domestic works gained access to the system. By the end of the 1960s, the rules allowed retirees to collect actuarially reduced benefits at the age of 62 as opposed to the traditional retirement age of 65. Finally, changes in the early 1970s yielded substantial cost-of-living adjustments and raised survivors' benefits from 82.5% to 100% of the deceased spouse's entitlement.
By the early 1980s, it became clear that the expansion had gotten ahead of itself. High inflation and stagnant wage growth over the preceding decade led to predictions that Social Security revenue and trust fund assets would be insufficient to cover benefit payments starting in 1983. The legislative response, enacted later that year, introduced a series of adjustments to correct the trajectory. Among other things, previously exempt federal workers were brought into the tent, a portion of Social Security benefits were subjected to income taxation (revenue which cycled back to the trust fund), and scheduled increases in the payroll tax rate were accelerated.
The impact of these changes was profound. Even now, the trust fund's balance continues to grow every year. In 1983, the fund held less than $20 billion in assets. Five years later, it held $103 billion. Fast-forward another two and a half decades, and the balance is nearly $2.7 trillion. The reason? Every year since 1983, the system has taken in more revenue than it paid out in benefits.
The culprit behind the coming Social Security crisis
With this as a backdrop, you might naturally conclude that any concern over the solvency of Social Security is much ado about nothing. In 2013, for example, the Social Security Administration recorded $744 billion in total receipts versus $680 billion in expenditures. The net result was a $64 billion credit to an already flush Social Security trust fund. At almost $2.7 trillion and growing, the fund alone is equal to nearly four times the program's annual expenditures.
Unfortunately, a closer look reveals three problematic trends. Starting in 2010, the Social Security system has paid out more in benefits each year than it has received from its share of payroll taxes. How is this possible? Didn't I just say it is continuing to run annual surpluses? I did, but the excess is due in large part to interest earned on assets in the trust fund's portfolio. Last year, for instance, the fund took in $641 billion in tax revenue and received $98 billion in interest income.
An additional, related problem is that the number of workers contributing to the system is declining relative to the number of beneficiaries. A decade ago, there were 3.9 workers paying into the system for every beneficiary drawing from it. The ratio today is 3.5, and it's projected to drop to 2.4 by 2040. Finally, while the Social Security system is continuing to run annual surpluses, they are rapidly declining in size. In 2006, the surplus was $181 billion. Last year, it was only $64 billion. And soon annual surpluses will be replaced by deficits.
The culprit underlying these trends is clear: demographics. Following World War II, the U.S. experienced a surge in fertility rates, yielding the baby boomer generation. At the baby boom's peak in 1956, 3.61 children were born to the average American woman of childbearing age. This was higher than in the past and higher than it has been since. Over the last four decades, the average has been 1.94 -- which, it's worth pointing out, is insufficient to fuel population growth in the absence of immigration. And it's for this reason that the ranks of Social Security beneficiaries are growing relative to contributors, as the first cohort of baby boomers became eligible for benefits in 2008.
Projections of Social Security's insolvency
As a disclaimer, forecasts about the future are almost invariably inaccurate. Mere days before the Crash of 1929, for instance, Irving Fisher, once reputed to be the "the greatest economist the United States has ever produced," predicted that the stock market had reached "a permanently high plateau." And roughly a century before that, one of England's most highly respected scholars forecast that human population growth would soon outpace the planet's ability to provide subsistence, leading to widespread starvation.
That predictions are often inaccurate, however, doesn't mean they should always be ignored -- and this is particularly true when it comes to something as important as Social Security. Every year, the committee in charge of the program's trust fund releases short-term and long-term estimates about the future solvency of the system. According to the most recent forecast, the fund related to retirement benefits is expected to become insolvent sometime between 2029 and 2059, with 2034 identified as the most likely year in which it will be fully depleted.
Now, just to be clear, even in the absence of a legislative solution like steeper payroll taxes or a higher retirement age, this won't translate into the end of Social Security altogether. Because it's ostensibly a pay-as-you-go system, there will still be revenue coming in each year from payroll taxes. But, as I explained above, those taxes are already insufficient to sustain the current level of payments, and this deficiency is growing with time. As a result, it's estimated that benefits will have to be cut by roughly 25% across the board in order to maintain a balance.
Are these projections apocalyptic? Perhaps not -- though I suspect many elderly Americans who rely on Social Security for the lion's share of their retirement income may disagree. Nevertheless, it's obvious that a legislative solution will be necessary at some point in the future. And the sooner one comes, the better, as relatively minor tweaks today will fend off draconian cuts for future generations.
How to get even more income during retirement
Social Security plays a key role in your financial security, but it's not the only way to boost your retirement income. In our brand-new free report, our retirement experts give their insight on a simple strategy to take advantage of a little-known IRS rule that can help ensure a more comfortable retirement for you and your family. Click here to get your copy today.