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The Coming Social Security Crisis Explained in Plain English

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.

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Read/Post Comments (23) | Recommend This Article (24)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 21, 2014, at 10:22 AM, harryhaff wrote:

    There really is no SS crisis, other than what is being manufactured. The first thing to do is to have the federal government replace ALL the money that was used for other purposes since SSs beginnings. The other is to eliminate the arbitrary income cap for SS contributions. The second step in and of itself would insure viability virtually forever. And it would not be a strain to any but the lowest income earners to increase the payroll deduction by 1 or 2%. Large companies, since they have stopped giving employees raises would be paying COL + 25% per employee per annum.Problems solved.

  • Report this Comment On August 21, 2014, at 11:00 AM, gadfly1000 wrote:

    harryhaff is unfortunately among the many who can only haff read, so he re-babbles the nonsense about the government taking money from the funds.

    Look again at the article, Harry, which correctly refers to all the INTEREST EARNED by the funds' required investments in.guaranteed special government bonds. The so-çalled "taking" of money by the government is, in fact, those investments, which are repaid at rather high interest rates. Without that process, the Social Security funds' value (and what it they could pay out) would be decimated by inflation.

  • Report this Comment On August 21, 2014, at 11:03 AM, gadfly1000 wrote:

    "a portion of Social Security benefits were subjected to income taxation (revenue which cycled back to the trust fund),"

    And there you have one of the solutions. Take the income tax that is being paid at the moment of contributions (the 6.2%, which all earners pay and which is subject to income tax) and recycle THAT income tax revenue into the Social Security funds, in the same way income tax on Social Security benefits goes directly back to the funds.

  • Report this Comment On August 21, 2014, at 12:22 PM, Zebra365 wrote:

    The myth is not that the Medicare trust fund will run out of money in 2030 or any other year; the myth is that the Medicare or Social Security trust funds ever contained any money or real assets at all. Politicians parrot this myth and use it as an excuse for not fixing the government’s greatest fiscal problems; some politicians may actually believe it.

    In order for something to be an asset it must have intrinsic value i.e., be real property, or be someone else's liability. If I write you a check, then you have an asset and I have a liability. If I write myself a check, then I have both the asset and the liability, it's a wash, no matter how big the check is.

    The Social Security and Medicare trust funds are composed only of checks written by the US Treasury, one part of the federal government, to the trust funds, another part of the federal government. Those checks are called "Treasury Bonds" but are not listed on the government books as "debt held by the public" and they cannot be sold in the open market to raise money to pay benefits like real Treasury Bonds could. It's a wash; just read the following from the Citizen’s Guide on page iv; that's exactly what it says to explain why the trust funds don't show up as an asset of the Government:

    "The Government also reports about $4.8 trillion of intragovernmental debt outstanding, which arises when one part of the Government borrows from another. For example, Government funds (e.g., Social Security and Medicare trust funds) are typically required to invest excess annual receipts in federal debt securities issued by the Treasury Department, thus creating liabilities of the Treasury and assets of the trust funds. These respective amounts are included in Department of the Treasury and investing agency financial statements, but offset each other in the preparation of the Governmentwide consolidated financial statements"

    So, either the Treasury report is wrong and there are real trust funds with real assets as the politicians say or the Treasury report is telling the truth and the trust funds are an accounting fiction. What the Treasury report really means is that ALL future payments for Medicare and Social Security will actually come from future federal taxes or borrowing, and not from any assets of the so-called "trust funds".

    There is a general expectation, promoted by politicians, that somehow payroll taxes are like a pension "paid in" when working and "paid out" later. Having "trust funds" supports this false expectation. The American people would be much better off, and the politicians worse off, if the finances of the federal government were open and clear. Until this particular illusion dies, we cannot have realistic discussions about the current financial condition of the federal government.

  • Report this Comment On August 21, 2014, at 1:58 PM, gadfly1000 wrote:

    No, zebra, those are real assets that pay real money to retirees who buy real goods and services with them.

    "payroll taxes are like a pension "paid in" when working and "paid out" later."

    Nobody EVER, EVER said such a thing. Social Security contributions are not pensions and they are not vested. They are a distribution of money from people working to those who are retired.

  • Report this Comment On August 21, 2014, at 3:24 PM, emailnodata wrote:

    GOP plan is to follow The Sequester Playbook and just let Social Security die.

  • Report this Comment On August 21, 2014, at 3:41 PM, colonelburton wrote:

    The solution is so simple....just do away with the $113k cap on contributions. If someone makes $200k, then that person pays SS tax on that amount. Keep the employer contribution capped at $113k, but the person making that $$ can pay the tax.

  • Report this Comment On August 22, 2014, at 11:13 AM, RxPro wrote:

    Just please let me opt out for the love of God. I don't want or need SS and I would even settle for paying 50% of current tax into the system.

  • Report this Comment On August 22, 2014, at 1:48 PM, JoeTheEconomist wrote:

    "The culprit underlying these trends is clear: demographics. "

    The first 50 years of retirees collected vastly more than they contributed. That is not a demographic problem. It is a problem of selling dollars for dimes. And we are surprised that the system breaks.

  • Report this Comment On August 22, 2014, at 2:03 PM, ButterflyOne wrote:

    This is the reason I appreciate this website - interesting dialogue! I don't think any of the political elite care about solving this problem. They don't care if the middle class disappears. Take your benefits as soon as you're eligible and maybe you'll get some benefit from what you have paid in.

  • Report this Comment On August 22, 2014, at 4:59 PM, SkepikI wrote:

    < please let me opt out for the love of God. I don't want or need SS and I would even settle for paying 50% of current tax into the system.>

    This will become the common sentiment once the 20-30 crowd realizes they've been had, bamboozled, lied to, fleeced, and they have no hope to recover what they put in, other than most of the "solutions" proposed above which just take more out of their pockets (which they will never get back)....

    I figure the revolution begins about 2030 as the upper end of this demographic approaches 50 and despairs. At that point much like 12 years ago, when a similar fix was proposed, there will still be enough time for the opt outs to save and invest enough to replace or maybe outpace their SS fleece, uhh 'benefit". After that, it gets to be too late. I would have gone for this solution in 1999 and I would have been OK. By 2004 it was to late for me. The window where this works for individuals is brief say 45-50- earlier they are not interested or paying attention, later not enough time.

    Similarly for demographics the window is shorter than you think. 10,000 Baby boomers turn 65 every day...too late for the boomers (all) to opt out.

  • Report this Comment On August 22, 2014, at 5:48 PM, MrCheeryO wrote:

    Pretty poor article, imo. Where did the 2.7 trillion go?

    Greenspan Was Worried that the U.S. Would Pay Off It’s Debt, Causing the Fed to “Lose Control of Monetary Policy” … So He Suggested Tax Cuts for the Wealthy to INCREASE the Debt

    Yep that was all of about 13 years ago. Kind of surprised TMF would publish such a piece but the question is what to do now, "crisis" being more than a bit of editorializing. It is true that "income from assets" is a tiny portion of the average retirees income--again heavily tilted to to the upper percentiles. That received the supply-side tax cuts Reagan--->Bush heavily tilted toward the top percentiles. But a majority, bare majority voted for that. Maybe we should identify those people and "adjust" their SS checks accordingly.

    Just looking for real culprits, so we don't make the same mistakes. The same terrible ideas still float about in some circles. Surprised TMF would write and publish a piece more worthy of the Club for Growth or similar nonsense.

  • Report this Comment On August 22, 2014, at 6:23 PM, TMFBreakerRob wrote:

    Cliff Notes version:

    More money is going out than coming in. Changes will be required. ;)

  • Report this Comment On August 22, 2014, at 6:47 PM, malclave wrote:

    A Ponzi scheme will ultimately collapse?

  • Report this Comment On August 23, 2014, at 7:28 AM, JoeTheEconomist wrote:

    @SkepikI,

    The reason no one can opt-out is because if they do... There will be no money in the system to pay existing retirees.

    Here is the scam. We tell people that they can opt-out without telling them that the only thing that they are opting of is benefits. Instead of paying SS with payroll taxes we will pay them with income taxes from... the people who opted-out.

  • Report this Comment On August 23, 2014, at 12:00 PM, Mathman6577 wrote:

    Wow they really narrowed it down to a 30-year period which does a retirement planner absolutely no good.

    Congress, which is responsible for the system -- not the administration as most people think, will never let the system die because retirees as a demographic are generally well informed and vote (unlike the younger generations who only moan and groan about things and blame everyone else for their problems).

  • Report this Comment On August 24, 2014, at 6:12 AM, Janaka323 wrote:

    I am 33 years old and I don't think, or plan my retirement on social security. I interpret my social security as another tax, nothing to get back except higher future "contributions". Eliminate social security and income tax. Problem fixed...

  • Report this Comment On August 24, 2014, at 1:40 PM, SkepikI wrote:

    ^ perfect example. Lessee, 2030 is 16 years out, Janaka will be about 49, and notwithstanding the denial, will be mightily put out when the obvious fleece is staring him/her in the face. With JUST enough time to replace or better the SS benefit by good investing of SS taxes if let out of them (opt out) Janaka will be ahead to do so, IF they system lets Janaka out... I predict Janaka will be one of the revolutionaries in 2029 or 2030....and with good reason.

  • Report this Comment On August 24, 2014, at 10:04 PM, only1ferret wrote:

    I've never really thought about SS. I don't really have any idea how much I will get in 13 years when I am eligible. For the longest time I assumed it would be $0, but now I realize worse case it will just be reduced by up to 25% or so. Doesn't sounds like too bad of a deal.

    If you did away with the 113k cap, wouldn't that mean that people who exceed that would now be entitled to more $$ at retirement?

  • Report this Comment On August 24, 2014, at 10:23 PM, SkepikI wrote:

    ^ You presume that there is anything like equity or logic in the system....WHAT could possibly make you think that? Yet, your safe and somewhat logical conclusion is that you expect zero out of the system...this is just the sort of inconsistency that those making the rules depend upon. Good Luck.

  • Report this Comment On August 25, 2014, at 5:27 AM, rrlcsw wrote:

    EXCELLENT!

  • Report this Comment On August 25, 2014, at 8:16 AM, pops71408 wrote:

    As a 26 year old who, thank God, has been been disillusioned with SS and the theft government performs to keep it up, I am with only1ferret. I expect to receive nothing on my "investment" in other people! It's sad that when I discuss this with my peers, I am viewed as some crazy conspiracy theorist (admittedly I can be at time!) and ridiculed for maxing out my ROTH contributions since I was 18.

    In my generations defense, we have been failed by our elders. They have not done their job to teach us about proper finances and to think on our own...or at all. We have been taught that authority is right because they say so! Skepikl is right. Sadly, our eyes will be opened it 20 years...Hopefully we'll do something about it.

    Social Security is an outdated ponzi scheme that once actually served a purpose. I am all for it's complete removal, but I will settle for letting people opt out. Anything to let me keep my hard earned money and to invest it as I see fit (and odds are far more successfully than any government could!)

    Sorry for that rant, I get a little worked up when it comes to big, overbearing government.

  • Report this Comment On August 31, 2014, at 1:48 PM, seek21der wrote:

    If we didn't give SSI to the ELDERLY IMMAGRANTS that come to USA maybe that would help some thy have NEVER WORKED here in the USA and thy come here get SSI, when I applied for SSD I got DENIED because I did not have enough work credits, so how is it that we have to care for them and not our own !!! There trying to pass a BILL that if thy come over that there children would have to take care of them FINANCUALY and MEDICALY, NOT SSI !!!!

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John Maxfield
JohnMaxfield37

John has been writing for The Motley Fool since 2011. As a senior banking analyst, he covers the financial industry and the nation's largest banks in particular. He has a bachelor's degree in economics from Lewis and Clark College and a juris doctorate from Southern Methodist University. He's a licensed attorney in the state of Oregon, and resides in Portland with his wife and twin sons. View John Maxfield's profile on LinkedIn

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