Social Security plays a vital role in the financial security for tens of millions of Americans. However, we've known for years that Social Security faced a long-term challenge, as the large number of retiring Baby Boomers reflected a demographic shift that is predictably putting pressure on the program. As boomers retire, they stop contributing payroll taxes to the system and start drawing benefits out. That combination will force Social Security to start drawing from its trust funds, and the expectation is that those funds will run out of money within the next 15 years, according to the latest Social Security Trustees Report.
Social Security's current financial projections are consistent with past reports, but they leave out one key factor: the economic impact of the coronavirus pandemic. To be fair, the Trustees Report itself acknowledges that its figures didn't incorporate any projections about the outbreak, given the high level of uncertainty surrounding its likely effects. Nevertheless, that hasn't stopped others from taking a closer look at the question, and some of the initial estimates are extremely concerning.
3 things that will hurt Social Security's revenue
There are several ways in which Social Security could suffer financial pain from the coronavirus. The most obvious is the loss of revenue from payroll taxes due to high levels of unemployment. With more than 30 million people having filed claims for unemployment benefits between mid-March and late April, the loss of income is evident. Unemployment benefits are subject to income tax, but the federal government doesn't collect payroll taxes on unemployment checks, and so Social Security's primary income source will drop for as long as employment remains under pressure.
Second, lawmakers have contemplated taking action to offer payroll tax holidays for working Americans, which could further reduce revenue for Social Security. The CARES Act stopped short of an outright holiday, instead offering employers the opportunity to defer payments of their share of payroll taxes for 2020 over the following two years. That change in timing will have a minor impact on the trust funds, but what would really cause potential problems is if the federal government forgave tax liability for those payroll taxes in future legislation.
Finally, Social Security's trust funds also generate interest income from the securities in which they invest. Weak economic conditions have spurred the Fed to cut short-term interest rates to 0%, and those low rates could remain in place for a long time. The rate on the securities that Social Security has most recently acquired is 1.25%, down from 2.75% in early 2019. Social Security will keep the higher rates on longer-term bonds in its portfolio, but losing a percentage point and a half on even a portion of the $2.9 trillion in trust fund investments could cost tens of billions of dollars annually, hastening the depletion of the funds.
How bad could it get?
Short-term hits to the program would likely have a limited impact on the date that the trust funds run out of money. Where the real risk comes from is a prolonged recession, especially if it's severe.
A recent analysis from the Bipartisan Policy Center suggests that the retirement trust fund is in danger of running out of money as soon as 2029. Under its methodology, the group used the experience of the Great Recession in the late 2000s to estimate shortfalls between projected and actual revenue. If history essentially repeats itself, then the group sees revenue declining by nearly $2 trillion between now and 2029 -- enough to wipe out reserves six years sooner than anticipated. When that happens, it could cause an immediate cut in benefits of 24% for all Social Security recipients -- or even deeper cuts if the program decides to spare some recipients over others.
What can you do?
The sooner that lawmakers acknowledge that there's a problem and take steps to solve it, the easier it'll be to implement changes. However, the necessary work is anything but easy. Large payroll tax increases, dramatic benefit reductions, or increases in the retirement age would be necessary to close the gap, and none of those measures is particularly attractive in Washington right now.
From a personal perspective, the best defense against Social Security's problems is to ensure you have financial resources of your own to draw from when you retire. That way, even if Social Security sees major cuts, you'll have the capacity to make ends meet and remain financially secure in your golden years.