For nearly eight decades, the Social Security program has played a vital role in ensuring the financial well-being of tens of millions of seniors. An analysis from the Center on Budget and Policy Priorities finds that Social Security is responsible for keeping more than 22 million people out of poverty, including over 15 million seniors, whom the program is first and foremost designed to protect.

But no matter how important Social Security is to aged beneficiaries, the long-term disabled, survivors, or other folks who might otherwise qualify for a benefit, there's always been confusion regarding how the program operates. Perhaps no aspect of Social Security creates more question marks than the program's asset reserves. Let's take a thorough look at what these asset reserves are, and why they've been so vital over the past three decades.

A folded hundred dollar bill and twenty dollar bill partially covering a Social Security card.

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In short, asset reserves = aggregate net cash surpluses

To better understand Social Security's asset reserves, you first need a basic grasp of Social Security's two primary trust funds: the Old-Age and Survivors Insurance Trust (OASI) and the Disability Insurance Trust (DI). As the names imply, the OASI pays out benefits to aged beneficiaries and the eligible survivors of deceased workers, whereas the DI covers the long-term disabled and any spouses or children who might also qualify on behalf of a disabled worker. These programs are often referenced as one, known as the "OASDI" for simplicity, albeit keep in mind that these are two separate trusts.

The unwritten goal of lawmakers has been for Social Security's OASDI to collect more in annual revenue than it's paying out. In doing so, the program will run a net cash surplus at the end of the year. The aggregate balance of all of these net cash surpluses is what becomes Social Security's asset reserves, or excess cash. Just as you earn wages by working, and then pay your bills, and (hopefully) have money left over at the end of your pay period to put into savings or investments, lawmakers aim to have Social Security do the same.

Since the Reagan administration passed the last major overhaul of Social Security in 1983, the OASDI has run a net cash surplus every year. These surpluses ranged from just over $3 billion in 1986, to a stretch between 1999 and 2009 where $117.2 billion to $179.3 billion was socked away each year. As of Dec. 31, 2018, according to the Social Security Administration, the program was just shy of $5 billion in surplus money away from $2.9 trillion saved.

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What happens to Social Security's net cash surpluses?

However, the Social Security Administration doesn't simply take the cash that's collected but not paid out to beneficiaries and stick it into a vault to collect dust. Doing so would be a terrible use of the program's asset reserves, as it would lose purchasing power each year to inflation -- i.e., the rising price of goods and services. Rather, the Social Security Administration is required by law to invest any surpluses into special-issue securities. Most investments wind up in special-issue federal bonds that have maturities ranging from 1 to 15 years, with a small percentage of asset reserves invested in certificates of indebtedness. As of December 2018, the program's nearly $2.9 trillion in asset reserves was earning an average of 2.85% a year.

Why buy government bonds with Social Security's excess cash? The simple answer is that they're backed by the full faith and credit of the U.S. government, and therefore have an exceptionally small risk of default. The Social Security Administration isn't about to gamble with $2.9 trillion by investing it any other way.

In return for effectively lending the federal government money that it uses to fund line items in its budget (e.g., education, healthcare, defense spending, and so on), Social Security receives interest payments. In 2017, it collected $85.1 billion in interest from the federal government, or about 8.5% of the program's total income generated that year. And over the next decade, the Trustees report estimates that $804 billion in interest income will be collected from the program's asset reserves.

I know what you might be thinking: "Wouldn't it be better if the federal government paid back what it has borrowed?" The answer is no. Again, if the federal government were to pay back Social Security all at once, not only would it need to find a new source of $2.9 trillion in borrowing capacity, but Social Security would no longer be generating any interest income on its excess cash. The program would actually be worse off if that happened.

A baby boomer in deep thought with hand on his chin.

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What if Social Security's asset reserves dwindle or disappear?

Of course, if you've been following the annual Trustees report, or have listened to the media discuss Social Security's outlook in recent years, you're likely well aware that Social Security's foundation is cracking a bit. Due to a number of ongoing demographic changes, such as the retirement of boomers, increased longevity, and growing income inequality, we'll soon witness a shift in the program that hasn't happened since 1982. Namely, Social Security will expend more than it collects each year.

On one hand, the program has almost $2.9 trillion in asset reserves, meaning it can handle persistent net cash outflows...for a while. But by 2034, the latest report forecasts that all $2.9 trillion will be completely gone. So, what happens then?

To begin with, it's important to note that as the program's asset reserves dwindle, its ability to generate interest income will become more challenging, even if interest rates -- which influence bond yields -- move higher. If and when this excess cash disappears, Social Security will lose one of its three sources of revenue.

However, it's also imperative that folks understand this doesn't mean bankruptcy or insolvency for Social Security. The program's other two sources of revenue -- the 12.4% payroll tax on earned income and the taxation of benefits -- aren't going anywhere. As long as Americans keep working, money will continue to flow into Social Security for disbursement to eligible beneficiaries (albeit the amount paid out each month may decline by 2034).

In sum, Social Security doesn't need a cent in asset reserves to still exist and make payments. Having asset reserves simply puts Social Security on better long-term footing and gives lawmakers more lead time if changes to the program need to be made.

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