The Social Security Trust Fund: Everything You Need to Know

The Social Security trust fund helps keep many retirees from financial disaster. Image source: Getty Images.

What is the Social Security trust fund? It's something that many haven't heard of and that others have many misconceptions about, thinking that the government is wrongfully borrowing from it and not simply letting those funds be an investment. Many also wrongfully think it's going broke soon. Let's clear everything up now.

Your friend, Social Security

Social Security is rather critical for most Americans. It pays close to 60 million Americans, with benefits totaling $883 billion in 2015. About 40 million recipients are retirees collecting retirement benefits. Other recipients include dependents of those retirees, disabled workers and their dependents, and survivors, including children.

According to the Social Security Administration, the majority of elderly beneficiaries get 50% or more of their income from Social Security, while 21% of married elderly beneficiaries and 43% of unmarried ones get fully 90% or more of their income from Social Security. According to the White House, without Social Security income, the percentage of elderly Americans living in poverty would surge from 15% to more than 50%.

How much money are we talking about, per retiree? Well, the average monthly retirement benefit was recently $1,350 -- or $16,200 per year. Those who enjoyed above-average earnings collect above-average benefits, but even so, the overall maximum monthly Social Security benefit for those retiring at their full retirement age was recently $2,639 -- or about $32,000 for the whole year. Social Security income typically amounts to about 40% of what the beneficiary used to earn while working.

Social Security income takes a lot of stress out of retirement. Image source: Getty Images.

The Social Security trust fund, explained

To understand the Social Security trust fund, let's review how Social Security works. As you might have noticed on your paycheck, workers get 6.2% of their wages withheld as a Social Security tax. What many don't realize, though, is that their employers cough up a corresponding 6.2%, for a total 12.4% tax on earnings. (Unfortunately, those who are self-employed have to pay both the employer and employee portions, forking over the entire 12.4% on their own.)

You might think that the money you pay into Social Security goes into an investment account with your name on it, growing until you're paid from it in your retirement, but that's not what's going on. Instead, the money that you and about 168 million other people pay into the Social Security system is used to pay the benefits owed to current beneficiaries. For a long time now, there has been more money coming in than going out, so the process proceeded smoothly, with the surplus funds going into the Social Security trust fund.

The "Social Security trust fund" term encompasses two funds: The Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund. Managed by the Department of the Treasury, they permit our government to contain assets collected and to keep track of inflows and outflows. There's a board of trustees that watches over the trust funds and reports to Congress annually on their condition. By law, funds are spent only on benefits and administration, and assets in the funds are invested only in securities guaranteed by the U.S. government. The Treasury makes "special issues" available solely for the trust funds. They differ from traditional marketable Treasury securities by being less vulnerable to changes in value because of overall market conditions. In other words, these investments are structured so as to never lose value. These securities then generate interest that can be used to pay benefits and can be redeemed or sold over time, too.

Many people misunderstand this process, and some (such as politicians) mischaracterize it, suggesting that the government is borrowing from, or "raiding" the Social Security trust fund. To help you see why that's not fair, consider this: If you invest in U.S. bonds, you're giving the government money, and the government is promising to pay back your investment at a certain time (when the bond "matures") and to pay you interest, too. You're lending money to the government, and the government is borrowing from you -- and rewarding you, too. It's not raiding your bank account or stuffing suspect IOUs into your pocket. The Social Security trust fund, like you, is simply investing money and is receiving interest along the way, too.

Social Security is likely to be around for a long time. Image source: Getty Images.

Is the Social Security trust fund going broke?

Another misconception about the Social Security trust fund is that it's on the verge of collapse. It's actually not going broke any time soon. It does face some challenges, though. Here's what's going on.

It used to be that there were many more Social-Security-tax-paying workers than beneficiaries, and that kept the system flush with funds. But as people have been having fewer children and living longer, the contributing-workers-to-beneficiaries ratio has been falling. Back in 1950, the ratio was 16.5, with about 48 million workers supporting close to 3 million beneficiaries. As of 2013, it was just 2.8 -- and it's expected to hit 2.1 by 2035.

Thus, while the Social Security trust funds have been running a surplus in every year since 1984 -- meaning that they took in more money than they paid out -- the surpluses are likely to stop around 2020. All is not lost then, though. At that point, the Social Security system can rely on incoming interest payments to make up the funding deficit -- for a while. According to several government estimates, Social Security funds are likely to see their reserves run dry between 2033 and 2037 if no changes are made. If that happens, payment checks won't disappear, but they'll likely shrink by about 25%. There's a good chance that changes will be made, though, to put the program on sounder ground.

What those changes will be is anyone's guess, though. Lots of possibilities have been floated. For example, it's been estimated that fully 77% of the trust funds' shortfall could be eliminated by increasing the Social Security tax rate for employers and employees from its current 6.2% to 7.2% in 2022 and 8.2% in 2052. This wouldn't be a new kind of move. The tax rate was increased in 1983, to bolster the program ahead of many baby boomer retirements.

Another possibility is taxing all of each worker's income, instead of just the first $118,500 of it. Many don't realize it, but there's a cap on how much of our earnings are taxed for Social Security -- for 2016, that cap is $118,500. Most of us are thus taxed on all our income, but those lucky enough to earn, say, $1,118,500 pay no Social Security tax on a million dollars of their income. Eliminating the earnings cap over a 10-year period is estimated to be able to wipe out 71% of the trust fund shortfall.

Social Security has been a lifesaver for millions. It's so important that it's quite likely that Congress will authorize further investment in the program, to shore it up -- or even expand it -- so that it can aid many more.