We've been spending more on Social Security benefits than we're collecting in payroll taxes since 2010, and that's bad news because it means that the trust fund that's making up the difference between outlays and tax receipts is going to run dry in 2030, according to number crunchers at the Congressional Budget Office (CBO). If so, then rules mandating that payments can't exceed payroll tax revenue will cause an across-the-board 29% reduction in Social Security benefits in 13 years.
Running on "E"
Social Security is funded by a 12.4% payroll tax on income up to $127,200 that's split between workers and employers.
Until 2010, the amount collected in payroll taxes exceeded payments to Social Security recipients, and as a result, the government was able to build up a trust fund. Currently, this trust fund is making up the difference between what's being collected in payroll taxes and what's being paid out to recipients, but that's causing the trust fund's balance to drop.
Unfortunately, the shortfall is expected to continue because the ratio of longer-living baby boomers to workers is increasing. Eventually, the trust fund itself will run out of money in 2030 and that has the CBO forecasting an across-the-board 29% cut to benefits.
What it means for you
The shortfall means that you might not receive the Social Security income you've been promised.
The amount you receive in Social Security benefits depends on your personal work history, but generally speaking, the program is designed to replace about 40% of your pre-retirement income. As a percentage, low-income households have more of their income replaced than high-income households due to the progressive nature of how Social Security benefits are calculated.
The calculation is complex and it involves inflation-adjusting your monthly income over 35 years and then reducing that number at specific income thresholds. For example, in 2017, a beneficiary will get 90% of their first $885 in adjusted monthly earnings in monthly benefits, but only 15% of any monthly adjusted earnings above $5,336.
Although the amount received in benefits varies widely from person to person, the average retired worker is receiving $1,360 per month in Social Security benefits this year, and the average retired couple is receiving $2,260 per month in benefits (if both are receiving benefits). Therefore, if the future 29% reduction in benefits were to happen this year instead, average payments to recipients would fall to $965.60 and $1,604.60, respectively. Given Social Security estimates that 21% of retired couples and 43% of retired singles count on Social Security for 90% of their retirement income, these future reductions could have dire consequences for millions of Americans.
How to fix it
So far, Congress has kicked the can on Social Security reform that could shore up its financial footing. However, a number of proposals have been discussed that could delay or avoid the mandatory reduction to benefits in 2030, and it's likely that Congress will act before the trust fund runs out of money.
One proposal is to increase the full retirement age, or the age at which people qualify for 100% of their monthly Social Security benefit. In the past, that age was 65, but it's steadily increasing based on a schedule set by Congress in 1983; and in 2017, it is 66 years and two months for people born in 1955. The full retirement age will increase by two months per year until it reaches age 67 for people born in 1960 and later.
If the full retirement age is pushed further back, fewer beneficiaries could help Social Security's trust fund last longer. A gradual increase to age 68, for example, could fill 16% of the shortfall, says the AARP.
Other proposals to reform Social Security include taxing income earned above the current $127,200 limit to increase tax revenue, means-testing to reduce Social Security payments to wealthy Americans, and changing the calculation that's used to determine whether inflation mandates that Social Security benefits be increased.
The AARP reports that applying the payroll tax to 90% of total earnings ($274,200 in 2016) could close 29% of the gap in Social Security's funding, and taxing all income could fill 71% of the funding gap. Also, reducing benefits paid to the top 25% of income earners could fill 3% of the funding gap, while changing the inflation calculation so benefits increase 0.3% slower per year could close the gap by about 21%.
The prospect of working longer, getting less in benefits, or paying more in taxes is understandably unappealing, but the country's demographics suggest that some form of reform will be necessary if we want to avoid this mandatory cut to benefits. Overall, because Social Security could look different in the future, it's more important than ever to build up your own retirement savings and to fully understand strategies that can boost your benefit payments in retirement.