Social Security's trust fund is in trouble. It is expected to run out of cash within the next 19 years, putting benefits at risk of cuts in the neighborhood of 23%. That worrying situation brings people out of the woodwork with all sorts of off-the-wall theories for the causes behind its troubles. Key among them is the theory that one political party or the other has been "stealing" from the trust fund in order to pay for welfare or wars (pick your party), thus depriving seniors of their promised benefits.
In reality, the trust fund has always been used as a means to finance overall Federal debt, enabling the Treasury to borrow at lower rates than it would otherwise be able to. That loan from Social Security to the Treasury isn't robbery -- indeed, Social Security actually benefits from the interest it receives from the bonds it gets from the Treasury in return for the borrowed cash.
These days, with Social Security not covering its direct costs from the taxes it receives, that arrangement is actually a benefit keeping the program afloat. However, as the trust fund dwindles, that process will reverse, and the Treasury will have to borrow more externally.
How does it work?
Before 2010, Social Security generally took in more in tax revenue than it paid out in benefits. The cash flows worked more or less in line with the flowchart below:
Step-by-step, the process looked something like this:
- You and your employer paid Social Security taxes
- Social Security paid its benefits out of the taxes received
- The surplus Social Security tax receipts were loaned to the U.S. Treasury
- The U.S. Treasury gave Social Security bonds in return for that loan
- The U.S. Treasury paid Social Security interest on those bonds
Those bonds make up the Social Security trust fund, which finished up 2013 at around $2.76 trillion. If you've ever seen reports on the U.S. debt, you'll note that it's often reported as three numbers: "Total debt," "debt held by the public," and "intragovernmental holdings." The Social Security trust fund represents a large portion of those intragovernmental holdings. The table below from TreasuryDirect.gov shows that total debt value as of Aug. 14:
Since 2010, Social Security taxes have not been sufficient to directly cover benefits, so Social Security has stopped directly loaning new money to the Treasury. Right now, and for the next few years, the combination of taxes and interest earned from those Treasury bonds is sufficient to cover Social Security's costs, but that is expected to change around 2020.
What happens next?
Around 2020, unless the law changes or the economy grows its way out of this funding problem, Social Security expects to start redeeming its bonds, cashing them in to cover the costs of its benefits. When that happens, the intragovernmental holdings value will start declining without changing the "total debt" number. That will force the Treasury to borrow more money from the public to avoid a default.
Unlike Social Security, which has to invest its money in Treasury bonds, the public is not obligated to buy Treasury bonds. Ordinary investors can choose where to put their money and need to balance the risks and potential rewards of every investment they make. As a result, there's a real chance that interest rates will rise as a result of the Treasury's need to offer higher returns to attract lenders with more alternatives than Social Security has.
Even if that does come to pass, it won't happen all at once. The Social Security trust fund is expected to deplete over the time between 2020 and 2033, so the Treasury will have a little over a decade to refinance the entire debt currently held by Social Security. Additionally, around 2033, once the trust fund does empty, unless the law changes, Social Security will be forced to cut payments rather than borrow money to pay its originally expected benefits.
Put it all together, and you can see that Social Security's trust fund has not been robbed. It has been used to finance the national debt, though. That arrangement initially helped the Treasury borrow money more efficiently. Now that Social Security's tax income no longer covers its payments, that financing arrangement is set to help Social Security instead for the next 19 years or so.
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Chuck Saletta is a Motley Fool contributor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.