Social Security is one of the most important sources of retirement income for Americans, and its uncertain future makes policy makers watch the program's financial condition closely every year. As a result, the annual release of the government report that provides a financial snapshot of how the Social Security trust fund is doing gets a lot of attention. Theoretically due on March 31, the report is routinely late, although the late-June release date for the 2016 Social Security Trustees Report is earlier than its 2015 counterpart's publication time last year. The 272-page report [opens PDF] released on June 22 largely confirmed the concerns that previous installments have raised, but there were a few noteworthy changes that deserve further examination. With that in mind, let's take a closer look at the 2016 Social Security Trustees Report to make sure you understand the three most important highlights from it and how they could affect Social Security's financial prospects down the road.
1. Social Security's overall financial status is largely unchanged from last year, but a temporary fix to disability funding bought some time.
Most of the longer-term projections concerning the key retirement portion of Social Security remained almost identical to last year's. Most recipients are covered under the Old Age and Survivors side of Social Security, because that's the fund that pays retirees and their families the benefits they've earned. The 2016 report left unchanged its projection that this part of the program will pay full benefits to retirees and family members until 2035. Beyond that date, income from payroll taxes and other sources that are earmarked for old-age benefits will cover only 77% of the program's obligations, which is consistent with last year's figures if you assume that the retirement portion of the trust fund is kept separate from the disability side.
However, things have gotten a lot better for the Disability Insurance portion of Social Security. According to last year's projections, the portion of the trust fund that helps to fund disability benefits was expected to run out of money during 2016. Lawmakers took action to reallocate revenue toward the disability portion of the trust fund for a three-year period. According to the 2016 report, that move has pushed out the expected date of disability reserve depletion to the third quarter of 2023 -- essentially buying about seven years before the issue will come up again.
Eventually, most policy makers anticipate an effective merger of the two funds. The Trustees Report says that if a merger were to occur, the combined funds would run out of money in 2034, which is the same date as last year's projections showed.
2. Providing for Social Security's future will take sizable changes in the current law.
The Social Security Trustees Report has traditionally presented options for policy makers to consider in fixing the long-term financial threats to Social Security. As they have in the past, this year the trustees focused largely on either increasing payroll taxes to boost revenue for the program or reducing benefits for Social Security recipients, either now or in the future.
If the government were to rely solely on a payroll tax boost to ensure Social Security's financial future, it would take a large increase to the current payroll tax rate. Right now, Social Security receives 12.4% of wages up to $118,500 for each worker. Half of the tax, or 6.2%, comes from withholding from employee paychecks, while the other 6.2% represents what employers owe on their employees' behalf. In order to keep Social Security fully solvent over a 75-year period -- the usual benchmark the trustees use -- that 12.4% figure would have to rise to almost 15%. The 2.58-percentage-point increase is actually slightly smaller than last year's 2.62-percentage-point figure, but it still represents a major gap to fill.
Benefit reductions are also an option, but they would have to be draconian as well. If benefits were reduced permanently and immediately for all current and future beneficiaries, it would take a 16% cut to maintain solvency. If you apply the cuts only to future beneficiaries, a larger cut of 19% is necessary. The Trustees Report suggests that lawmakers could use a combination of strategies to close the funding gap, but the magnitude of moves necessary shows just how daunting a challenge that will be.
3. Procrastinating a Social Security solution would be even more costly, despite some uncertainty about the projections.
The Social Security Trustees Report acknowledges that its predictions aren't perfect, and some lawmakers therefore justify their delay in addressing the problem in the hope that dire projections will prove to have been overly pessimistic. But the trustees' own sensitivity analysis shows that the problem is very unlikely to go away by itself.
Specifically, even if you assume best-case scenarios for the program, which include assumptions like shorter lifespans for beneficiaries, lower levels of unemployment for those paying payroll taxes, and higher fertility rates to boost the labor force, the trust fund is unlikely to remain solvent past 2045 -- a year earlier than in last year's analysis. Moreover, worst-case scenarios could exhaust the trust fund as early as 2029. The trustees put just a 5% chance on the actual result falling outside this 2029 to 2045 time frame.
There's therefore little reason for lawmakers to wait and hope for the best. Moreover, if they do, the solutions become more costly. The 2016 report says that payroll taxes would have to rise by nearly 3.6 percentage points in 2034 if no changes are made before then, or a 21% reduction in all benefits would need to take effect. The government has an incentive to make less extreme moves sooner to cushion the blow.
The 2016 Social Security Trustees Report's results didn't have any major changes from last year, and those in the government will have to keep finding ways to make progress toward a longer-term solution. Otherwise, Social Security will stay on track toward greater financial difficulties less than two decades into the future, and making financial plans about retirement will involve a lot more uncertainty.
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.