For the vast majority of current and future retirees, Social Security income is indispensable. A recent survey from national pollster Gallup found that 89% of current retirees lean on their monthly Social Security payout to some varied degree to make ends meet. Meanwhile, 84% of nonretirees anticipate relying on the program as a "major" or "minor" source of income during their golden years.
Unfortunately, America's most vital social program finds itself in a heap of trouble.
The average retired worker could lose out on over $5,800 annually in 12 years
Every year for more than eight decades, the Social Security Board of Trustees has released a lengthy annual report that examines the inner workings of America's top social program. It provides revenue collection and benefit payment data since Social Security's inception, as well as making numerous prognostications about where the program is headed over the next 10 years (short-term) and 75 years (long-term).
Since 1985, the Board of Trustees report has cautioned that the combined Old-Age and Survivors Insurance Trust (OASI) and Disability Insurance Trust (DI) wouldn't generate enough aggregate revenue to maintain existing payouts, including annual cost-of-living adjustments (COLA), over the long-term. This expected cash shortfall has steadily been growing, on a nominal-dollar basis, over the past three-plus decades.
If there's a silver lining to this, it's that Social Security is in no danger of going bankrupt or becoming insolvent. The lion's share of revenue collected by the Social Security program derives from the 12.4% payroll tax on earned income (wages and salary, but not investment income). As long as Americans continue to work, revenue will always be flowing into Social Security for disbursement to eligible recipients. If you qualify for a Social Security benefit, you're going to receive some form of payout.
However, if things were to continue on the path they are now, the Board of Trustees has estimated that an up to 23% cut to OASI benefits may be necessary by 2034 to sustain payouts through 2096 without any further reductions. The OASI is what provides a monthly Social Security check to 48 million retired workers.
What would a 23% benefit cut actually look like by 2034? If we assume COLA grows by an annual average of 2% through 2034, the average retired worker benefit would grow from $1,661/month to begin 2022 to approximately $2,107/month by 2034. If you're wondering why I chose a 2% cost-of-living adjustment, it has to do with the Federal Reserve targeting that rate for long-term inflation. If the OASI's asset reserves (excess revenue collected since inception) were to run out by 2034, as the Board of Trustees has projected, the average retired worker would lose $484.51 in monthly income, or $5,814 over the full year.
Demographic shifts are creating all sorts of problems for Social Security
With the combined OASI and DI hitting an all-time record of roughly $2.9 trillion in asset reserves in 2020, you might be wondering how it's possible that Social Security itself is in such a bind. The answer lies with a number of demographic shifts that are hurting the program's revenue-generating capacity or increasing disbursements.
For example, most people are probably well aware that baby boomers have been retiring in greater numbers for years. As these folks hang up their work coats and enter retirement, there simply haven't been enough new workers to take their place. As the worker-to-beneficiary ratio declines, it puts more strain on Social Security.
What you might not realize is that historically low birth rates are on track to have the same effect over a longer period. In 2020, the approximately 3.6 million babies born was the lowest figure in over four decades. What's more, U.S. fertility rates -- the expected number of children a woman will have in her lifetime -- hit an all-time low in 2020. With birth rates nowhere close to generational replacement levels, the worker-to-beneficiary ratio looks destined to fall even more.
To build on this point, immigration is another problem for Social Security -- albeit not for the reasons you might have heard. The financial well-being of the program is dependent on a healthy amount of legal immigration into the United States each year. Immigrants tend to be younger, which means they'll spend decades in the labor force contributing to Social Security via the payroll tax. Over the past quarter of a century, legal immigration into the U.S. over a rolling five-year period has nearly been halved.
Income inequality is an issue, too. Roughly 94% of working Americans pay into Social Security with every dollar they earn. That's because, in 2022, all earned income between $0.01 and $147,000 is subject to the payroll tax. But for the remaining 6% of well-to-do workers, earned income above $147,000 is exempt from the 12.4% payroll tax in 2022. That's well over $1 trillion in earnings escaping the payroll tax.
Expect a long wait before lawmakers tackle Social Security's shortcomings
One additional concern that hasn't been touched on yet is that lawmakers aren't the quickest when it comes to tackling Social Security's shortcomings.
For instance, the program was facing depletion of its asset reserves in 1983, similar to what's been predicted by 2034 for the OASI, or 2035 for the combined OASI and DI Trusts. It was known for years in advance that Social Security would exhaust its asset reserves and necessitate benefit cuts if lawmakers didn't act. It took until 1983 (the same year asset reserves were estimated to be depleted) for the Reagan administration to pass the last truly sweeping bipartisan overhaul of the program. In other words, history would suggest that it'll be at least a decade before Congress is forced into action.
It also doesn't help that Democrats and Republicans aren't compelled to work with their opposition. Since both parties have proposed their own workable solutions to "fix" Social Security and strengthen the program, neither is incentivized to find common ground.
Although Social Security will be there for you, whether you're already retired or just entering the labor force for the first time, it's more important than ever to invest for your future. The last thing you want is to have to place your faith in lawmakers and hope they act quickly enough to stave off a potential 23% Social Security benefits cut.