The 2018 Social Security trustees' report was recently released, and it reiterated what we already knew -- that Social Security is going to be in serious trouble unless we take action.

However, there's a little more to the story than that. For example, did you know that Social Security has nearly $3 trillion in reserves right now? Or do you know why Social Security is expected to be in trouble and what we could do about it?

With that in mind, here are five key takeaways from the 2018 Social Security trustees' report that help paint a clearer picture of the current and future state of Social Security, and what we could do to fix it.

Social Security card inserted in money.

Image source: Getty Images.

Social Security added $44 billion to its reserves in 2017

Social Security's program expenditures were $952 billion in 2017. Meanwhile, the program generated a total of $997 billion in income -- $911 billion of this came from non-interest sources (mainly payroll taxes), and another $85 billion came from interest income on Social Security's reserves. (Note: Numbers may not add perfectly due to rounding.)

Speaking of Social Security's reserves, there is now $2.982 trillion in reserves in the Social Security trust funds, up from $2.848 trillion a year ago. This money is held in special-issue U.S. Treasury securities and serves two main purposes.

First, it is a sort of "rainy-day fund" that Social Security can (and will) use to continue paying benefits if the program runs a deficit. We'll talk more about deficits in a bit, but the point for now is that Social Security has enough in reserves to cover about three years' worth of benefits, even if no more payroll taxes ever came in.

Second, Social Security's reserves are a key source of income for the program. Because the reserves are in the form of U.S. Treasury securities, they earn interest. In fact, if you look at the numbers in the first paragraph of this section, you'll see that the $85 billion in interest income is the reason Social Security didn't run a deficit in 2017 as payroll taxes fell significantly short of the program's expenditures.

But, Social Security is still expected to run out of money in 2034

Unfortunately, the surplus Social Security produced in 2017 is the last one we're going to see unless significant changes are made to the program.

For 2018, Social Security is expected to run a $2 billion deficit, and the annual deficit is only expected to get worse from here. By the end of 2027, the reserves are expected to be down to about $2.2 trillion, and the deficit is expected to grow rapidly after that point. By 2034, the reserves are expected to be completely drained.

Specifically, the OASI (Old Age and Survivors Insurance) trust fund is expected to run out in 2034, at which point the incoming tax revenue will only be enough to cover 77% of promised benefits. The DI (Disability Insurance) trust fund is expected to run out in 2032, two years earlier, but the disability program's income will still be sufficient to pay 96% of scheduled benefits.

Costs are exceeding income from payroll taxes, and it's going to get worse

Obviously, the reasons why Social Security are in trouble are too complex to thoroughly discuss here -- that's why the 2018 Trustees' Report is 270 pages long.

However, the problems with Social Security can be simplified as follows:

  • Americans are living longer lives.
  • The massive baby boomer generation is going to be gradually retiring over the coming decades.

The effect of this is that not enough people are going to be paying into Social Security, and too many people will be drawing benefits. Historically, there have been about 3.2-3.4 workers paying into Social Security for every one worker collecting benefits, but this is now down to a ratio of 2.8:1. By 2035, when most baby boomers will have retired, this is expected to drop dramatically to just 2.2 workers per beneficiary.

Social Security payroll taxes are assessed at a rate of 12.4% of taxable payroll, with half of this coming from the employer and the other half from the employee. In 2018, the cost of Social Security is expected to be 13.81% of taxable payroll, but thanks to the interest income from the reserves, the deficit is expected to be mild. However, by 2039, the program's costs will rise to about 16.38% of taxable payroll, and there won't be any more reserves to help close the gap.

There's a $13.2 trillion long-term deficit in Social Security funding

In all, the 75-year unfunded obligation is expected to be 2.68% of taxable payroll, which translates to a present value of $13.2 trillion. This is significantly worse than the $12.5 trillion deficit projected in last year's report.

In other words, this means that if we wanted to keep the program's characteristics (retirement age, benefit calculation, etc.) and the payroll tax rate the same, we would need to somehow add $13.2 trillion to Social Security's trust funds.

The sooner we try to solve the problem, the easier it will be

Obviously, there's not $13.2 trillion sitting around somewhere that can be magically added to Social Security's balance sheet. So, the main ways to fix the deficit remain increasing taxes or cutting benefits.

While there's no easy choice here, it's important to realize that the sooner we do something, the less painful it will be. The Social Security Trustees estimate that if we wanted to fix Social Security now, a 2.78% payroll tax increase (1.39% for employees) or a 17% across-the-board benefit reduction would do the trick. On the other hand, if we wait until 2034 when the reserves are depleted, we would need a 3.87% payroll tax increase or a 23% across-the-board cut to accomplish the same thing.

Now, there are certainly other ways to increase tax revenue than an across-the-board tax increase, and there are ways to cut benefit expenditures without an across-the-board cut, but the point is that the sooner we address the problem, the more palatable the solution is likely to be.

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