You may have heard that Social Security is broke, bankrupt, or something to that effect. While this is a bit of an exaggeration, the reality is that Social Security isn't in the best financial shape from a long-term perspective. Here's a rundown of the latest projections, and a chart that illustrates why Social Security is expected to run out of money.
Social Security isn't broke -- yet
First of all, it's important to point out that Social Security is actually in decent financial shape for the time being. Not only does the program have $2.85 trillion in reserves, but it ran a surplus last year and is expected to continue to do so through 2021.
Unfortunately, that's where the good news ends. Beginning in 2022, annual deficits are expected to start, and they are forecast to get big in a hurry. In fact, the reserves are expected to be completely depleted by 2034, at which point Social Security will only be able to pay out about three-fourths of promised benefits.
Here's the problem
The problem is that the baby boomer generation, which is the largest generation in history to reach retirement age so far, is going to gradually retire over the next decade or so. This will greatly increase the number of Social Security beneficiaries and remove millions of taxpaying Americans from the workforce. In addition, life expectancies have been on the rise, so Social Security beneficiaries are expected to collect their benefits for more years than in previous generations.
In a nutshell, there won't be enough workers paying into the system to support the retirees who will be collecting benefits.
Here's a chart that illustrates the problem with Social Security perfectly. The blue line represents the costs of Social Security (benefits paid, administrative costs, etc.), while the red line represents the program's income from payroll taxes and taxes on current beneficiaries' retirement benefits, both as a percentage of GDP. Notice how the red line has crossed over the blue line and, more importantly, look at how wide the gap is expected to get in the coming decades.
Before we discuss what this means, there's one quick note. In the first section, I mentioned that Social Security ran a small surplus in 2016 and is expected to do so for several more years, although the chart indicates a small deficit. In addition to Social Security's payroll tax income, the program also makes money by earning interest on its reserves. This additional income can close a small deficit, but won't be nearly enough to make a difference as the cost versus income gap continues to widen.
To put some dollar amounts behind the chart, consider the gap in the year 2035. Social Security's income is expected to be 4.77% of GDP, while the program's costs are forecast to reach 6.1% of GDP, a shortfall equal to 1.33% of GDP. Based on the projected 2035 U.S. GDP of $43.7 trillion, this means that Social Security's funding gap will be $581 billion. And that's just in one year. This is why Social Security's massive reserve stockpile is expected to be depleted so quickly after deficits start in 2021.
What can be done to fix the problem?
The good news is that there is time to fix the problem, and there are several ways it could happen. A potential Social Security fix could take the form of tax increases, benefit reductions, or some combination of the two. And the sooner it's done, the less painful it'll be -- in fact, I wrote another article about how two gradual tax changes, if implemented now, could solve the Social Security funding problem for good.
Having said that, there's no way to know for sure what form an eventual Social Security reform package might take, but history tells us that something will be done. It's just a matter of what and when.