The Social Security program, which pays benefits to more than 61 million people a month (including 42 million retired workers), generated $957.5 billion in revenue last year, according to the latest Social Security Board of Trustees report.
The vast majority of this revenue (87.3%) was derived from a 12.4% payroll tax on earned income between $0.01 and $127,200. The maximum taxable earnings amount is raised in most years to keep pace with the National Average Wage Index. Thanks to the cap, roughly nine out of 10 working Americans are paying into Social Security with every dollar they earn, while higher-income workers are receiving at least a partial payroll tax exemption on earned income above $127,200.
The taxation of Social Security benefits -- yes, Social Security benefits may be taxable -- accounted for nearly $33 billion (3.4%) in revenue last year. Individuals earning more than $25,000 annually, and couples with more than $32,000 in earned income, have at least some of their Social Security income exposed to federal income tax.
Lastly, 9.2%, or a bit over $88 billion, came from the interest earned on Social Security's excess cash. The program has been cash-flow positive since the Amendments of 1983 were passed, meaning its asset reserves have been growing with each passing year. According to the latest update from the Social Security Administration in July 2017, it had just shy of $2.91 trillion in spare cash.
But have you wondered what Social Security does this with spare cash, and how it earned $88 billion from this cash in 2016? Let's have a look.
How Social Security invests its $2.9 trillion in cash
Social Security income is practically considered a guarantee by eligible seniors, meaning the SSA isn't at liberty to take major risks with its more than $2.9 trillion in asset reserves. Therefore you won't see any stock market investments or crazy derivative plays here. Instead, nearly all of the money (all but $30.6 billion) is invested in special issue bonds that are only available to the Social Security trust funds. The remainder is invested in certificates of indebtedness. Below you can see a breakdown from the SSA of where its $2.91 trillion is invested as of July 2017.
There are two key things worth noting in the tables above. First, the average interest rate that the SSA is generating on its $2.91 trillion in excess cash is 2.902%. This gives us a pretty good idea of what to expect in interest income for the program this year, and it's also currently ahead of the national inflation rate, which has been hovering between 1.5% and 2% for some time. In other words, the program is generating real money, even with inflation factored in.
However, a worrisome trend can be seen in the maturity dates of the special issue bonds. You'll note that all of the highest-yielding bonds are expected to mature within the next couple of years. Some $882 billion (about 30% of the programs' asset reserves), yielding between 3.5% and 5.125%, is set to mature between 2018 and 2023, likely leaving the program with bonds ranging in yield from 1.375% and 3.25% and thus significantly reducing its interest-earning power.
The reason this is happening is that the Federal Reserve, which controls monetary policy, kept its federal funds target rate at a record low for seven years. As a result, newly issued bonds over that period have had significantly lower yields attached. If there is some solace, the Fed has raised its federal funds target rate by 0.1% since December 2015, which should help to boost future special issue bond yields. Nevertheless, with the federal funds target rate still well below its historical norm, it's plausible that the average yield on Social Security's excess cash will drop in the years to come.
An even bigger problem awaits Social Security
However, declining yields aren't even the biggest concern for Social Security and its asset reserves. According to the Board of Trustees, the program will begin paying out more in benefits than it's generating in income beginning in 2022. Why, you ask? Look no further than the ongoing retirement of baby boomers, a steady lengthening of life expectancies, and pervasive income inequality that has allowed the rich to live substantially longer than the poor, and thus to collect their higher monthly payouts for a longer period of time.
Per the Trustees report, Social Security could peak at approximately $3 trillion in spare cash in 2022, only to see this entire cash pile completely exhausted by 2034. Between 2034 and 2091, the report forecasts a budgetary shortfall of $12.5 trillion. In plainer English, the ability to generate interest income will begin to be compromised in less than five years, and it will presumably disappear by 2034 unless Congress passes new legislation. That's $88 billion in annual income that Congress must find a way to replace, even as millions of older workers are retiring each year and becoming eligible for Social Security benefits.
If anything, this data serves as a great reminder to working Americans that Social Security shouldn't be their primary source of income during retirement. Formulate a budget, sock away extra income with each paycheck, consider investing some of your money in the stock market, and understand the basic tax implications for what you do save and invest. Yes, Social Security will be there when you retire, but the Social Security you know today may look very different in less than two decades.