Each and every month, the Social Security Administration sends out benefits to more than 61 million people, of which 68% are retired workers. These retired workers are especially reliant on the income they receive from Social Security to make ends meet. More than three out of five retired workers receive at least half of their monthly income from Social Security, with about a third generating 90% to all of their monthly income from it.
This reliance is what makes what I'm about to tell you all the more worrisome: Social Security appears to be on a collision course with disaster, which has some folks questioning whether it'll survive for another generation.
Is Social Security doomed?
According to the latest report from the Social Security Board of Trustees, America's most important retirement program is undergoing a number of demographic shifts. This includes the ongoing retirement of an average of 4 million baby boomers a year, which is weighing down the worker-to-beneficiary ratio, and the steady lengthening of life expectancies. Since 1960, life expectancies in the U.S. have risen by about nine years. When signed into law in August 1935, Social Security was designed as a supplementary income source for low-income workers for a few years. Today, the average 65-year-old will live another 20 years. A rising number of beneficiaries who are living for a longer period of time is a recipe for a lot of strain on the program.
The Trustees report estimates that Social Security will continue to generate more income than it pays out in benefits through 2021. But beginning in 2022, and each subsequent year thereafter, the cash outflow from the Trust will be higher than the total revenue generated for the program. Despite an expected $3 trillion in asset reserves by 2022, the Trust's coffers are forecast to be completely exhausted by 2034.
Many of today's younger workers believe the depletion of this cash means the end of Social Security is near. Fortunately, that won't be the case.
Social Security could (in theory) survive forever
In spite of its woes, and the real possibility that its excess cash could be completely gone within the next 17 years, Social Security could survive forever. You heard me... forever.
The secret to Social Security's longevity can be found in the way the program is funded.
Working our way backwards, the smallest contributor is the taxation of Social Security benefits, which provided $32.8 billion of the $957.5 billion collected in 2016. Yes, your benefits may indeed be taxable by the federal government (and 13 states, for that matter). If you're currently receiving benefits and earn more than $25,000 as a single filer or $32,000 as a couple filing jointly, at least half of your benefit could be exposed to federal income tax.
The next-largest revenue contributor is the interest earned on its asset reserves. Last year, $88.4 billion in interest was generated from investing close to $2.9 trillion into special issue bonds and certificates of indebtedness. As of October 2017, the Trust was generating an average interest rate of 2.904% on $2.88 trillion in excess cash. Unfortunately, this extra cash will begin to dwindle in 2022 and beyond. By 2034, assuming it's completely exhausted, this revenue source will disappear.
The bulk of the funding for the program comes from a 12.4% payroll tax on earned income between $0.01 and $127,200 as of 2017. This top figure, known as the maximum taxable earnings cap, is adjusted annually on par with the National Average Wage Index (assuming a positive cost-of-living adjustment for Social Security beneficiaries). Last year, $836.2 billion in revenue was collected from workers who paid into Social Security via the payroll tax.
This payroll tax is the magic sauce that'll allow Social Security to live on past 2034. In essence, as long as Americans continue to work and be paid, the payroll tax will do its job by funding Social Security's Trust and allowing disbursements to be made to eligible beneficiaries. Unless the primary funding mechanism for Social Security were changed away from the payroll tax, there will always be money collected that can be paid out to retired workers, survivors, the disabled, and their eligible dependents. In theory, it could survive forever.
There's a big difference between survival and sustainability
What current and future Social Security recipients need to understand is that there's a distinct difference between survival and sustainability. Social Security's survival is not in question. People will keep working, payroll taxes will be collected, and benefits will be paid out. You will receive benefits when you, your grandchildren, and their grandchildren retire, assuming no changes to the funding mechanism in Congress. It doesn't, however, ensure that current payouts will remain sustainable.
According to the Trustees report, there's a $12.5 trillion budget shortfall in the program between 2034 and 2091. Unless Congress figures out a way to boost revenue collection by this amount, the expectation is that an across-the-board cut to benefits of up to 23% may be needed to sustain payouts through the year 2091. That's not a promising forecast if you're among the 62% depending on Social Security for at least half of your income. It is, though, a much rosier forecast than Social Security being insolvent and not providing you a red cent during retirement.
Here's the real problem
The debate moving forward shouldn't be centered on whether Social Security will survive. It will thanks to the payroll tax. Instead, it should be focused on how best to bridge its funding shortfall over the next 75 years so as to reduce or eliminate the magnitude of the drop in future payouts.
Democrats have suggested lifting or removing the maximum taxable earnings cap (the aforementioned $127,200 figure), which would require that well-to-do people pay more. Eliminating it completely and subjecting all earned income to the payroll tax might be enough to eliminate the $12.5 trillion shortfall. The downside to this plan is it wouldn't provide any extra incentive to the wealthy since there's a maximum monthly benefit at full retirement age of just $2,687 in 2017.
Republicans have argued that adjusting the full retirement age (the age where you become eligible to receive 100% of your retirement benefit) higher to take into account increased longevity would be the smarter move. Increasing the full retirement age to 68, 69, or even 70 would require future retirees to wait longer to receive 100% of their benefit. In effect, it's a cut in benefits to future retirees that could reduce costs for the program.
Which method makes more sense? That's the issue: They both solve the funding problem. Until there's some sort of cooperation between Democrats and Republicans or a supermajority in Congress, Social Security's funding issues are liable to be kicked down the road.