For more than 75 years the Social Security program has protected the financial well-being of our nation's retired workforce. Today, more than 41 million retired workers are receiving monthly benefit checks from Social Security, a majority of whom need that income to meet their expenses during retirement.
Plenty of solutions, but no sure fix
Yet in spite of the relief that Social Security brings to millions of Americans, the program is facing a long-term crisis. Two major demographic shifts -- the ongoing retirement of baby boomers, and the lengthening of life expectancies -- are expected to flip the switch on Social Security and take the program from a cash inflow to a cash outflow by the year 2020. According to the 2016 report from the Social Security Board of Trustees, the Trust is expected to have depleted its more than $2.8 trillion cash stockpile by the year 2034, at which time benefits may need to be slashed by up to 21% to sustain the program for future generations.
The interesting aspect of Social Security's long-term problem is that more than a dozen solutions exist. Not every solution that's been proposed would fix the budgetary shortfall in its entirety, but each would at least make some headway. The holdup is in finding a generally acceptable solution at a time when both political parties in Congress are at their wits' end with one another.
President Trump pledged throughout his campaign that he wouldn't be making changes to Social Security. Instead, Trump's plan involves improving economic growth so as to collect more revenue via the payroll tax. Trump believes that by reducing and simplifying taxes for individuals and corporations, announcing a $1 trillion, 10-year infrastructure spending bill, renegotiating America's trade deals, and promoting the domestic energy industry, he'll be able to boost U.S. GDP growth enough to increase incomes and therefore payroll tax revenue. Whether or not Trump's plan will work remains to be seen.
Here's how Social Security can be great again
However, a genuine fix for Social Security doesn't require any arm-twisting -- it only needs balance. A combination of three factors could make Social Security great again for future generations of retirees.
1. Increase revenue by adjusting the payroll tax earnings cap
The first step to fixing Social Security for many future generations to come involves generating more revenue for the program. There are really two ways to do this, but one method has a substantially higher approval rating than the other.
One method would be to increase payroll taxes across the board for all working Americans. The Trustees report listed an actuarial deficit of 2.66% in 2016, suggesting that a 2.66% increase in the payroll tax should sustain the program without the need for benefit cuts through the year 2090. The problem with enacting an across-the-board hike is that it's a potential burden on lower-income and middle-class individuals and families.
The considerably more popular approach, based on polling, would be to adjust the payroll tax earnings cap.
In 2017, workers pay a 12.4% payroll tax on wages of between $0.01 and $127,200 (this 12.4% is often split down the middle between you and your employer). Any wages earned above $127,200 are exempt from the payroll tax. What this means is more than 90% of all working Americans are paying into Social Security with every dollar they earn, while wealthier folks are only paying into Social Security on a percentage of their annual income.
Two potential fixes include raising Social Security's maximum taxable earnings to a higher level and eliminating the payroll tax earnings cap in its entirety. According to the "Voice of the People" survey, eliminating the payroll tax earnings cap would cut the budgetary shortfall by 66%. Since only 7% of the population would be affected by raising the payroll tax beyond its current level of $127,200, the idea of raising it or eliminating it is rightfully popular among the public.
2. Gradually increase the full retirement age
As revenue is increased on one end, minor benefit cuts should be accepted on the other for future retirees.
A few of the proposals to control Social Security's expenditures have included freezing benefits for the wealthy; freezing the purchasing power of benefits of all recipients; and switching the measure of cost-of-living adjustments (COLA) from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to the Chained CPI. The Chained CPI takes into account the idea of "substitution." In other words, if one good or service becomes pricy, the consumer will simply substitute it for another less-expensive good or service. The CPI-W doesn't take this into consideration. Long story short, the Chained CPI would lead to smaller COLA increases for seniors.
None of these proposals is particularly well liked by the public. However, one cost-cutting idea has drawn the support of nearly four in five Americans according to the Voice of the People survey: raising the full retirement age.
Your full retirement age is the point at which Social Security deems you eligible to receive 100% of your monthly retirement benefit. Filing for benefits before you reach this age means a permanent reduction in your monthly payout, while waiting to claim benefits until after you hit your full retirement age will lead to a bigger payout.
Currently, Social Security's full retirement age is increasing by two months per year until 2022, when it'll reach 67 years of age for everyone born in 1960 and after. Gradually adjusting the full retirement age higher to age 68, 69, or 70 would coerce healthier seniors to stay in the workforce longer and presumably add extra payroll tax revenue to the program. It would also take into account the fact that life expectancies have risen by roughly nine years over the past five decades.
Though raising the full retirement age essentially means a pay cut for all working Americans when they retire, it has plenty of support from the public.
3. Encourage Americans to save
The final way to make Social Security great again is to adjust the saving and investing habits of working Americans.
According to the Social Security Administration, Social Security benefits are only designed to replace about 40% of a person's working wages. Yet we know from the data that the program is being leaned on heavily by millions of seniors. Much of this blame comes down to the paltry national household savings rate in the U.S. of just 5.5% as of Nov. 2016. This is down by more than 50% from 50 years ago, and it's substantially lower than what citizens in other developed countries save.
In order to make Social Security great again, we have to ween the American public off of relying so heavily on its benefits. How do we do that? Though there are countless ways, I'd opine that easing some of the key restrictions on retirement accounts ought to do it.
For example, the Traditional IRA and Roth IRA are both incredible tools to help consumers save for retirement. The Traditional IRA, which is funded with pre-tax dollars, can reduce a person's current-year tax liability, whereas the highly popular Roth IRA, which is funded with after-tax dollars, allows an account holder's money to grow completely tax-free for life. The problem with both IRAs is their annual contribution limit of $5,500 for workers aged 49 and under, and $6,500 for those aged 50 and up. If these limits were higher, we'd probably see workers pour more savings into Roth IRAs.
It seriously could be this simple: increase revenue, cut benefits modestly for future retirees, and encourage better saving and investing habits.
Your move, Congress.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.