In terms of sheer importance, there isn't a program that comes close to matching Social Security. Though you could make an argument that Medicare might be equally indispensable to retirees, there isn't a social program out there that divvies up a guaranteed payout to 47.5 million aged beneficiaries each month or that keeps more than 15 million retired workers above the federal poverty level.
Yet, in spite of being such a crucial cog to retirees' bottom lines, there's a lot that seniors, or the American public as a whole, just don't understand about Social Security.
On May 15, MassMutual Financial released a five-question, true-false online Social Security quiz for adults aged 50 and over. While you'd expect retirees and pre-retirees to be well-versed on the program, 47% of the 1,007 respondents surveyed failed (i.e., answered three or fewer questions correctly). Though this is technically an improvement from the failure rate to a 10-question online quiz three years prior, it's still pretty dismal. And the truth of the matter is, what folks don't know about Social Security could cause them to leave money on the table during retirement.
With this in mind, let's look at what we might call Social Security's heartbeat -- its Trust funds -- and explain what they are, how they get funded, and where the money that's collected winds up.
What are Social Security's Trust funds?
Broken down to its basic components, Social Security's Trust funds are two separate accounts where money collected is deposited. These accounts are:
- The Old-Age and Survivors Insurance Trust (OASI), and
- The Disability Insurance Trust (DI)
The OASI is responsible for paying retired worker benefits to qualifying persons aged 62 and over, as well as spouses, ex-spouses, and children who may qualify for a benefit based on a qualifying workers' earnings history. It also provides benefits to widows, widowers, and the children of a qualifying deceased worker. As of the July 2018 snapshot from the Social Security Administration, 52.2 million people were receiving an OASI benefit (46.3 million retired, and 5.9 million survivor).
Meanwhile, the DI handles payouts to persons who are disabled over the long term, as well as the spouses or children who may also qualify for a benefit based on the disabled worker's earnings history. As of July, 10.2 million persons was receiving a Social Security disability benefit.
It's worth nothing that while a combination of the OASI and DI Trust's doesn't technically exist, the Social Security Board of Trustees report, and even the SSA, will refer to the fictitious "OASDI" when describing the full program or discussing its long-term outlook. For the sake of simplicity, I'll mostly be referring to Social Security's two Trusts as the collective OASDI going forward.
How are Social Security's Trust funds funded?
Social Security's OASDI brought in $996.6 billion in revenue last year, and is estimated by the Trustees report to cross the $1 trillion barrier in revenue collected this year. It gets that funding from three different sources.
- Payroll tax: Without question, the largest contributor is the 12.4% payroll tax on wage income of up to $128,400, as of 2018. Any earned income below this amount is subject to Social Security's payroll tax, while wage income above this amount is exempt. More than 90% of all working Americans pay into the program on every dollar they earn. Last year, $873.6 billion of the $996.6 billion collected was derived from the payroll tax.
- Interest income: The second-largest contributor is interest income earned by Social Security's $2.9 trillion in asset reserves. Between 1983 and 2017, Social Security collected more revenue each year than it paid out in combined benefits and in administrative costs, leading to a $2.9 trillion cash stockpile that's earnings interest (I'll discuss this in more detail in the next section). In 2017, interest income generated $85.1 billion for the OASDI Trust.
- Taxation of benefits: Lastly, $37.9 billion was collected in 2017 as a result of taxing Social Security benefits. Introduced in 1984, following passage of the 1983 Amendments, half of a beneficiary's payout becomes taxable at the federal level if their adjusted gross income plus half of their benefits exceeds $25,000 ($32,000 for couples filing jointly). In 1993, a second tier was added that allows 85% of Social Security benefits to be taxed if above $34,000 for single filers and $44,000 for couples filing jointly.
How is this money disbursed/used?
Now that you have a better idea of what the OASI and DI are, as well as how money is collected by Social Security, let's take a closer look at what happens once the money is in these funds.
As you can probably (rightly) guess, most of the money collected each year winds up going right back out to pay beneficiaries. In 2017, $941.5 billion of the $952.5 billion in program expenditures were benefit payments. This included $798.7 billion to the OASI Trust, and $142.8 billion to the DI Trust. The remaining expenditures include $4.5 billion to the Railroad Retirement financial interchange, and $6.5 billion in administrative costs. This left a surplus of $44.1 billion in 2017 that was added to Social Security's asset reserves.
Then, there's the money that's left over, known as Social Security's asset reserves. As noted, almost $2.9 trillion has been built up over the past 35 years. By law, the Social Security Administration is required to invest its excess cash into special-issue bonds, as well as certificates of indebtedness. The average yield on its investment portfolio, which has numerous maturity dates and yields, is 2.9%. An even easier to way to understand this situation is to think of it this way: Social Security is lending the federal government money, and the federal government is paying interest on that loan, plain and simple.
While Social Security might appear complex on the surface, it's probably a lot easier to understand than you realize.