Ask a majority of Americans what they think about Social Security -- the program intended to provide income to qualifying individuals so as to help prevent financial hardship -- and they'll tell you it's broken. According to a CNN/ORC International poll conducted in 2011, more than 70% of respondents believed Social Security was in "crisis" or had "major problems."
For one, different generations have different ideas of what Social Security has done for them or could do for them in the future. A retiree currently receiving Social Security will likely tell you how their monthly benefits have helped them make ends meet, with 85% of those aged 65 and up noting in that same CNN/ORC poll that Social Security has been "good" for them personally. Ask a millennial, however, and you're apt to get little more than a shrug, as most millennials have experienced no direct benefit of Social Security.
Another reason Americans lack faith in Social Security is the fact that we have passed the proverbial tipping point: More money is being paid out than is coming in. The reason this is happening is a large demographic shift. Baby boomers are retiring en masse, and there aren't enough young, working adults to replace the benefits baby boomers are receiving. Not to mention that life expectancy in the U.S. is improving, meaning people are living longer and drawing down on the Social Security Trust that much more.
What might Social Security look like in 20 years?
Based on the current rate of reserve depletion and estimates from both the Congressional Budget Office and the Social Security Administration, the reserve fund will be gone somewhere between 2033 and 2037. In other words, Social Security will look vastly different in 20 years.
But what might that future look like? Let's have discuss a few scenarios.
The do-nothing approach
Regulators are left with two basic choices as they stare down the depletion of the Social Security Trust Fund: do something or do nothing.
If regulators choose to do nothing, the system will not -- I repeat, will not -- go bankrupt, despite pervasive myths that it will. However, beneficiaries' payouts will almost assuredly decline.
According to forecasts from the Social Security Administration, if beneficiary payouts were reduced to 75%, or three-quarters of their current payout level, the revenue coming in via workers' paychecks would funnel enough into the system to keep Social Security benefits flowing through 2087.Granted, no beneficiary wants to see cuts to the system when they retire, but all in all, something is better than nothing.
Practical ways Social Security may be changed
It's more likely, however, that the regulations surrounding Social Security will be altered to extend full benefits to beneficiaries for as long as possible. Here are some of the methods that lawmakers might employ to improve the long-term outlook for Social Security.
1. Boost payroll taxes
One simple way to fix the Social Security inflow shortfall is to merely boost the current payroll tax of 6.2%. With the exception of the payroll tax holiday for employees in 2011-2012, the current payroll tax has remained unchanged at 6.2% since 1990. Prior to 1990, though, this tax increased with some regularity. While most consumers will fight tooth-and-nail to avoid higher taxes, when it comes to their financial well-being upon retirement, they're all for paying more into the system.
According to a study (link opens PDF) released by the National Academy of Social Insurance in early 2013, close to 80% of respondents said they'd be on board with tax increases if it meant a more secure future for themselves, their families, and the program as a whole. Of course, these same respondents also expected that minimum benefits would increase and that cost-of-living adjustments would rise from their current levels, too.
NASI's study noted that if the payroll tax were raised from 6.2% to 7.6%, it would allow Social Security benefits to continue to be paid in full for the next 75 years. While it's tough to predict what lawmakers will do, raising the workers' portion of the payroll tax would seem to make a lot of sense.
2. Eliminate the cap on taxable earnings
Another option, which could come in addition to the previous option or by itself, is the elimination of earnings caps with regard to Social Security taxation.
As it stands now, workers are taxed at the rate of 6.2% on earnings up to $117,000. Any income above that level isn't taxed, meaning the Warren Buffetts of the world pay a tiny portion into the Social Security program as a percentage of their annual earnings, though they make far more than the average person.
The easy way to remedy this is to drop the Social Security earnings cap altogether and allow all earnings to be taxed. According to NASI's findings -- which assumed an orderly elimination of this cap over a 10-year period that would only affect 5% of the population -- the extra income generated by taxing higher-income individuals throughout the entire year would close the Social Security funding gap by 71%.
3. Raise the retirement age
Though higher taxes might be a strong possibility, it's possible that payroll taxes could remain unchanged if other cuts are made. One potential solution is boosting the retirement age.
Currently, the Social Security Administration considers 66 to be full retirement age, though for persons born in 1960 or later, the full retirement age is scheduled to increase to 67. NASI calculated that raising the retirement age to 68 would reduce benefits paid by 7% and cut the current funding gap by 15%. Raise that to age 70, and the savings would triple to 21%, while the gap would be narrowed by 25%. Of course, these cuts are only feasible if persons currently aged 25 to 45 have adequate retirement savings, otherwise the financial hardship of waiting those few extra years could more than offset the benefits received from a reduction to the funding gap.
4. Means-testing for beneficiaries
Another popular option that NASI addressed is means-testing beneficiaries to determine whether they really need Social Security income.
Let's again recall that Social Security was implemented as a fail-safe to prevent financial hardship. If an individual or couple is bringing in six figures annually during retirement from their investment portfolio or through royalties, does they really need an additional $20,000 to $30,000 per year in Social Security benefits?
Logically, the answer here would be no, as their retirement income would appear to be more than sufficient to keep them out of financial hardship. However, these individuals paid into the system just like everyone else, so the idea of denying them the right to get their share of benefits upon hitting retirement age didn't exactly sit well with respondents polled by NASI.
A plethora of options
The truth of the matter is that there are even more possible outcomes than I've listed above, but the solution to the Social Security Trust funding shortfall likely lies in some combination of the above paths.
In my opinion, raising the retirement age will likely be the toughest sell, given the poor savings rate in the U.S. and the fact that few Americans are adequately prepared for retirement. As a recent study from Bankrate showed, 36% of all Americans -- and more than two-thirds of those aged 18 to 29 years -- haven't saved a dime toward their retirement. Instead of benefiting the nation as a whole by shrinking the fund gap, pushing benefits further out could potentially cause even more problems.
Working individuals staring down this funding gap will clearly see some change during their lifetimes, but they shouldn't be reliant on lawmakers to fix the problem. Instead, workers should focus on funding their retirement accounts as soon as possible so they can utilize the power of time and compounding gains to their advantage. And if workers have an adequate base of savings to live off of until they reach age 70, then they have the potential maximize their benefits received from Social Security.
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