Social Security is a financial lifeline that tens of millions of Americans simply couldn't do without. According to a study conducted by the Center on Budget and Policy Priorities back in 2016, the mere existence of Social Security ensures that 22.1 million Americans are kept above the federal poverty line. This includes almost 15.1 million retired workers, as well as 7 million adults and children who can qualify based on retired workers' income, as survivors of deceased workers, as disabled workers, or as the spouses or children of qualifying disabled workers. Social Security is simply that important.
Is Social Security's future in doubt?
Yet, this financial foundation for retirees, survivors of deceased workers, and the disabled, is facing the biggest hurdle of its more than eight decades of existence. The Social Security Board of Trustees 2017 report is forecasting that the program will begin paying out more in benefits than it's collecting in revenue by 2022. Just 12 years later, in 2034, Social Security's $3 trillion in asset reserves are expected to be completely exhausted.
This major speed bump in the road for Social Security isn't a shock to current beneficiaries, pre-retirees, working Americans, or lawmakers on Capitol Hill. Pretty much everyone knows it's there, and pretty much everyone understands that Social Security's current payout schedule isn't sustainable beyond 2034. Where there isn't so much agreement is in deciphering what will happen to Social Security once its asset reserves are depleted.
If you ask millennials (traditionally aged 18 to 34), they're bound to tell you that Social Security is in deep trouble, and that they don't expect to receive anything by the time they retire three-to-five decades down the road. In fact, a late-2017 Investopedia study questioned millennials about future Social Security benefits, and just 19% felt confident in the program. This meant that 81% of millennial respondents essentially aren't counting on Social Security being there for them when they retire.
Given how Congress has waffled on Social Security in recent years, I can fully understand the pessimism of millennials. It's not that Social Security's $12.5 trillion cash shortfall between 2034 and 2091 isn't fixable – both Democrats and Republicans have a core solution that would resolve the problem. Democrats would increase taxation on the wealthy to generate new revenue, while the GOP would raise Social Security's full retirement age to factor in increased longevity and reduce the program's long-term expenditures. The problem is that both of these proposed solutions work, meaning neither party has any incentive to find a middle ground and get a resolution passed in Congress.
Here's why 81% of millennials are dead wrong about Social Security
But, truth be told, 81% of millennials are dead wrong about Social Security's future. Though I don't fault them one bit for being worried about a program that's facing a monstrous cash shortfall, insolvency simply isn't on the table, and the payroll tax is to thank for that.
You see, Social Security is funded in three ways. The smallest contributor is the taxation of Social Security benefits, which was first introduced with the Amendments of 1983. Single beneficiaries with more than $25,000 in adjusted gross income (AGI), and couples filing jointly with over $32,000 in AGI, are subject to federal taxation on a portion of their benefits. In 2016, the taxation of benefits generated $32.8 billion of the $957.5 billion collected by the program.
The next-largest contribution comes from the interest earned on Social Security's asset reserves. This excess cash is invested in special-issue bonds and, to a much lesser extent, certificates of indebtedness. These assets are currently yielding an average of around 2.9%. In 2016, $88.4 billion in revenue came from interest on the program's asset reserves.
The biggest contributor, though, is the 12.4% payroll tax on earned income of between $0.01 and $128,400, as of 2018. If you're self-employed, you pay the full 12.4%, up to $128,400. However, if you're employed by someone else, your employer covers half of your payroll tax (6.2%), leaving you, the worker, to pay the other 6.2%, up to $128,400. In 2016, payroll taxes accounted for 87.3% ($836.2 billion) of what was collected. As long as Americans continue to work, the payroll tax will keep generating revenue that the Social Security Administration can then disburse to eligible beneficiaries. This payroll tax is the sole reason Social Security can never go bankrupt.
Survival doesn't equate to sustainability
The only way Social Security could ever be truly insolvent is if Congress were to change how revenue is collected. Last year, a GOP lobbyist proposed the idea that the payroll tax be eliminated as Social Security's primary funding mechanism and replaced with a value-added tax on consumption. Doing so would have tied Social Security's health to that of the economy, and in such an instance it could have destabilized the long-term solvency of the program. This proposal failed to gain any traction in Washington.
In short, as long as things stay as they are now, Social Security won't go bankrupt, and therefore will be there when millennials retire.
What isn't assured is the current payout schedule. Even though money will continue being collected via the payroll tax, a flood of baby boomers leaving the workforce, along with increased longevity, will weigh on the worker-to-beneficiary ratio. By 2034, should Congress do nothing, an across-the-board cut in benefits of up to 23% may be needed to sustain payouts through 2091. A cut in benefits is far from optimal, especially considering how 62% of today's retired workers lean on Social Security for at least half of their monthly income. Still, it represents a guaranteed payout for those who qualify for retired worker benefits.
It's OK to worry about Social Security's future, and it's advisable to plan on it being nothing more than a minor financial contributor. But to think it won't be there at all by the time millennials retire is just plain wrong.