For many retired Americans, Social Security isn't just a check they receive each month. It's a financial lifeline that keeps them above the federal poverty line and allows them to make ends meet. An analysis from the Center on Budget and Policy Priorities in 2016 found that the mere existence of Social Security income keeps 22.1 million people -- 15.1 million of whom are retirees -- out of poverty each year. It's simply that important.
Unfortunately, this crucial program is set to undergo some major changes in the years ahead. The latest Social Security Board of Trustees report, which was released last summer, estimates that the program will begin paying out more in benefits than it's generating in revenue beginning in 2022. A dozen years later, in 2034, the program's $3 trillion in asset reserves, built up over the previous four decades, is expected to be completely exhausted.
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What happens if Social Security completely exhausts its asset reserves?
The depletion of Social Security's asset reserves is one of the greatest sources of confusion among working Americans and retirees. The idea that the program's excess cash could disappear within a span of 12 years is viewed by quite a few people as a sign that Social Security simply won't be there for them when they retire. In fact, a survey conducted by national pollster Gallup in the summer of 2015 found that 51% of respondents didn't expect to receive a benefit from Social Security when they retired.
The belief that Social Security is going to run out of money is very real. Thankfully, it's also completely wrong.
If we think about Social Security as a business, things probably appear pretty dire. Since 1983, the program has been cash flow positive every single year -- and it's expected to remain so through 2021. Over this time, an estimated $3 trillion in excess cash has been built up. This excess cash has been invested primarily in special-issue bonds and, to a much smaller extent, certificates of indebtedness, which are yielding a little bit less than 3% annually.
But between 2022 and 2034, the cash outflow in the program is expected to accelerate with each passing year. This outflow is the result of a confluence of factors, including the ongoing retirement of baby boomers, lengthening life expectancies, growing income inequality, and below-average interest rates that have adversely impacted the program's interest income. By 2034, there simply won't be any excess cash, assuming Congress makes no changes to the program.
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If this were a business, it would be in very deep trouble. Thankfully, Social Security isn't a business. Benefits could be reduced (through the legislative process) in the future if the current payout schedule proves unsustainable.
The payroll tax is Social Security's knight in shining armor
The key factor at work here is Social Security's primary funding mechanism: payroll tax. In 2016, the payroll tax accounted for $836.2 billion of the $957.5 billion that was collected by America's most important social program.
Social Security's payroll tax of 12.4% is levied on wage income between $0.01 and $128,400, as of 2018. The upper figure is adjusted annually to match the inflation rate of the National Average Wage Index. Essentially, the payroll tax ensures that Social Security can never go bankrupt, and that it'll always have a clear source of revenue. As long as Americans continue to work and earn wage income, and assuming Congress doesn't adjust how Social Security is funded, payroll tax revenue will be collected, providing funds that the Social Security Administration can disburse to eligible beneficiaries.
In other words, Social Security can't run out of money. Period! However, that doesn't mean Social Security isn't in trouble.
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As noted, the program's $3 trillion asset reserve is expected to be gone by 2034. This suggests that the current payout schedule simply isn't sustainable. Unless Congress chooses to raise additional revenue, or finds new ways of closing the 75-year estimated cash shortfall of a projected $12.5 trillion, Social Security benefits for existing and future retirees may need to be cut by up to 23% come 2034.
The bad news here is that 62% of today's retired workers receiving a Social Security benefit rely on the program to provide at least half of their monthly income. A 23% cut to their benefits would definitely be felt, and would notably increase elderly poverty rates. The good news is that Social Security, despite a growing possibility of a cut to future benefits, will be there for you when you retire, in some capacity.
In sum, Social Security absolutely needs help from lawmakers in Washington, but it's in no danger of running out of money.
