By the time working Americans retire, a majority will be, in at least some capacity, reliant on Social Security income to make ends meet. Currently, more than three out of five seniors relies on their monthly payout for at least half of their income, without around a third (34%) leaning on the program for at least 90% of their income. Future retiree reliance is expected to be a bit lower, according to a Gallup survey, but still substantial.
However, America's most important social program is on shaky ground, and it's today's working Americans, along with pre-retirees, who could wind up paying for it. Whether you realize it or not, there's not one, two, or three, but up to four different ways your Social Security benefits could be reduced in the years and decades to come with virtual no action by lawmakers on Capitol Hill.
1. Full retirement age increases reduce aggregate payouts
Back in 1983, the Reagan administration passed the last major overhaul of Social Security. Facing a long-term actuarial deficit that was only about a third as big as it is now, the Amendments of 1983 introduced new means to generate income, as well as long-term ways to reduce the costs of the program. One of the means to control the latter was a gradual increase to the full retirement age.
Your full retirement age is the age, determined by your birth year, at which the Social Security Administration deems you eligible to receive 100% of your full retired worker benefit. If you claim benefits prior to reaching your full retirement age, you effectively accept a permanent reduction in your monthly payout. On the other hand, if you wait until after your full retirement age, you can actually further boost your monthly stipend.
When passed in 1983, the Amendments mapped out a two-year increase in the full retirement age, from 65 to 67, over a span of four decades. Right now, the full retirement age is increasing by two months per year, until 2022 where it'll cap out at age 67. As the full retirement age increase, future retirees have to either choose to wait longer to receive their full benefit, thus reducing the number of years they're collecting a benefit, or accept a steeper reduction to their payout if they claim early, hurting their aggregate payout over the long run. No matter how you look at it, aggregate benefits paid are reduced for future retirees.
2. Taxation of benefits is growing
Another component to the Amendments of 1983 was the introduction of the taxation of Social Security benefits. This new revenue stream applied ordinary federal income tax on 50% of single filers' or couples' Social Security benefits if they respectively earned more than $25,000 or $32,000 in adjusted gross income (AGI). A second tier was added in 1993 under the Clinton administration that allowed 85% of Social Security benefits to be taxed if a single filer earned above $34,000 in AGI, or over $44,000 for couples filing jointly.
When the taxation of benefits was first introduced, it only applied to around one in 10 households with seniors. However, The Senior Citizens League notes that as of 2016, 56% of senior households are now being taxed to some degree on their Social Security benefits. The reason? The income thresholds introduced in 1983 and 1993 have never been adjusted for inflation. Essentially, more and more seniors are becoming susceptible to the taxation of Social Security benefits with each passing year.
And if you're expecting this tax to disappear or be adjusted for inflation anytime soon, don't be too hopeful. The recently passed Republican tax law, which is projected to yield a $1.5 trillion deficit over 10 years, is going to require every cent in revenue that the federal government can collect. This essentially means the revenue collected from the taxation of Social Security benefits is now more important than ever, which means you have a better chance than not of kissing some of your benefits goodbye to Uncle Sam.
3. Purchasing power is in nearly constant decline
A third problem for current and future retirees is an ongoing decline in the purchasing power of Social Security dollars. An analysis by The Senior Citizens League found that the purchasing power of a Social Security dollar had declined by 30% since 2000. In effect, what once bought $100 worth of goods and services now buys $70 worth of goods and services.
Why is this happening? The simple answer is that Social Security's annual cost-of-living adjustment (COLA) isn't accurately keeping up with the true inflation that seniors are facing. The Consumer Price index for Urban Wage Earners and Clerical Workers, or CPI-W, is the inflationary tether that determines Social Security's annual COLA. However, as the name implies, it takes into account the spending habits of working-age Americans, not seniors. It, therefore, tends to overemphasize expenditures for transportation, education, apparel, and food, while underrepresenting the higher costs that seniors face for housing and medical care. In fact, medical care inflation has outpaced Social Security's COLA in 34 of the past 36 years!
Democrats on Capitol Hill have proposed changing the inflationary tether for Social Security to a measure that would more adequately take into account the spending habits of seniors. Unfortunately, doing so would only further compromise Social Security's long-term funding gap. Further, an inflationary measure for seniors, such as the Consumer Price Index for the Elderly, would still fail to account for Medicare Part A (hospital insurance) expenses, causing it to still underrepresent the true inflation seniors are facing.
4. The current payout schedule is unsustainable beyond 2034
And as the icing on the cake, the Social Security Board of Trustees released its annual report in 2017 and found that the program will be facing a major funding gap over the next 75 years.
According to the report, Social Security is expected to begin paying out more in benefits than it's generating in revenue by 2022. Just 12 years later, in 2034, the estimated $3 trillion in asset reserves held by the program at its peak in 2022 will be completely gone. Should this excess cash be depleted, there would be no interest income to be earned by Social Security via special-issue bonds and certificates of indebtedness.
More importantly, it would mean that the current payout schedule is unsustainable. The trustees report estimates that it could result in an across-the-board cut in benefits of up to 23% just to keep the program solvent through 2091. That's a reduction in benefits for current and future retirees.
In other words, the longer Congress waits to act, the more likely it is your Social Security benefit is being reduced.