Whether you realize it or not, big changes are underway with the Social Security program.
For the past decade, the number of newly eligible retired workers has climbed with each passing year. This is a function of more baby boomers reaching the eligible claiming age and, generally, people living longer. The result has been increasing strain on Social Security, a program currently leaned on by 62.7 million Americans each month, 43.4 million of whom are retired workers.
Social Security's asset reserves could soon be depleted
According to the latest Social Security Board of Trustees report, released in early June, the program is slated to do something not seen since 1982: expend more money than it generates.
Beginning in 2018 and continuing through 2034, the amount of money being disbursed to eligible beneficiaries is expected to rapidly increase. Over this time, the $2.9 trillion in Social Security's asset reserves (i.e., the aggregate of the net cash surplus the program has generated since inception) is expected to decline. Though this net cash outflow will be minimal at first (an estimated $1.7 billion in 2018), it'll begin soaring in 2020 and beyond. By 2034, the entirety of Social Security's asset reserves is expected to be gone.
What exactly happens to Social Security and your retirement paycheck if this $2.9 trillion in excess cash disappears? Let's take a closer look.
Payouts would continue
Now, the good news is that if Social Security completely burns through its asset reserves, your payout isn't going to go up in smoke -- the reason being that more than 91% of the program's revenue in 2017 could be categorized as recurring.
Most of the heavy lifting for Social Security is done by the 12.4% payroll tax on earned income of up to $128,400, as of 2018. Last year, $873.6 billion of the $996.6 billion collected by the program was generated solely from the payroll tax on earned income. As long as the American public continues to work and Congress doesn't change how the program is funded, the payroll tax will keep generating significant income that can be distributed to eligible beneficiaries.
The second recurring source of revenue for Social Security is the taxation of benefits. Signed into law in 1983 and implemented in 1984, the taxation of benefits allows the federal government to partially tax Social Security benefits at ordinary income tax rates if adjusted gross income plus one-half of benefits exceeds $25,000 for an individual, or $32,000 for a married couple filing jointly. An analysis from The Senior Citizens League finds that 56% of all senior households are paying tax on some portion of their Social Security benefit.
Interest income as a source of funding would disappear
However, the third (currently existing) source of Social Security revenue would disappear if the program's asset reserves are exhausted.
By law, the Social Security Administration is required to invest any excess cash into special-issue bonds and, to a lesser extent, certificates of indebtedness. These bonds and certificates of indebtedness with varying maturities and yields possess an average interest rate of almost 2.9%, as of September 2018. This interest income wound up generating $85.1 billion for Social Security last year. In other words, the federal government gains an easy source of borrowing, and the Social Security program reaps the reward of interest income in return.
However, as Social Security's asset reserves are depleted by a growing annual net cash outflow, the amount of interest income generated could decline, even with interest rates currently on the rise. By 2034, when the Trustees have projected a complete exhaustion of Social Security's asset reserves, interest income will disappear as an income source for the program.
Benefit checks would be cut by up to 21%
The real concern is that while Social Security payouts will continue ad infinitum as long as Americans keep working and payroll tax revenue is collected, the existing payout schedule isn't sustainable. If it was, there'd be no net cash outflow in the first place.
Should Social Security completely deplete its asset reserves, the Trustees have forecast the need for an across-the-board cut to benefits of 21% by 2034. This means retirees who've been receiving benefits would see their check reduced by 21%, and future generations of retirees would also get 21% less per month. If payouts were chopped by 21%, it's estimated that they wouldn't need to be cut again -- assuming no changes to program funding by Congress -- until 2092.
While it's great to know that Social Security will be there when you, your children, and even your grandchildren reach retirement, it's a bit unnerving to realize that your payout could be slashed in less than two decades' time. It's even scarier when you realize that 62% of today's aged beneficiaries are reliant on their Social Security check for at least half of their income. This is why Americans have called on lawmakers in Washington to put aside political rancor and resolve Social Security's projected $13.2 trillion cash shortfall between 2034 and 2092. Should Congress not get the job done, everyone will come out a loser.
So, to summarize: Social Security isn't going anywhere, but the depletion of its asset reserves has the real potential to shrink your take-home check.