Social Security is one of the most popular and successful entitlement programs ever, but it's in dire need of reform. The program is facing financial trouble that could lead to a devastating benefits cut within the next 15 years if lawmakers don't act.
While finding a solution will be a challenge, there are actually multiple proposals out there to fix funding shortages. While it's not yet certain if lawmakers will adopt any of them, chances are good at least some could find their way into a compromise bill to shore up the program. Here's what they are.
1. Full retirement age could change
Full retirement age (FRA), or the age when you get your standard benefit, started at 65 but was raised when Social Security was reformed in 1983. Now, it's between 66 and 67 depending on your birth year, and it could change again.
There have been various proposals to slowly raise it over time to 68 or 70. Some have also suggested indexing Social Security to longevity.
Unfortunately, if FRA is raised, that amounts to a de facto benefits cut because you either miss out on some years of income if you wait until FRA to retire or you get a smaller benefit due to early filing penalties. You also lose out on the chance to earn delayed retirement credits available if you retire after FRA.
2. COLAs could be recalculated
Cost-of-living adjustments (COLAs) are meant to help ensure retirement benefits keep pace with inflation. But one common proposal to fix Social Security is to change the way COLAs are calculated.
They're currently determined by using a pricing index that measures rising prices year over year. But some have suggested changing to a "chained CPI," which shows a slower growth in prices because it assumes consumers change their buying behavior if the cost of goods rises. This would mean a slower average increase in benefits, which is also a de facto benefits cut.
3. The payroll tax cap could go up
Social Security taxes are only paid on earnings up to a wage base limit (it's $137,700 in 2020). Proposals to shore up Social Security include lifting the cap to cover a higher percentage of earnings (most often to ensure taxes are paid on 90% of all earnings).
The problem is, benefits are paid out based on taxes paid in. If the cap was raised but a higher benefit was paid, this wouldn't really help the program's finances much. If the cap was raised but benefits weren't, it would fundamentally change Social Security, which has always been an earned benefit.
4. The payroll tax cap could be eliminated altogether
This option is similar to the above suggestion, but it eliminates the wage cap entirely rather than just raising it. It causes the same problems as raising the cap, but only exacerbates them as it could lead to some very wealthy people getting benefits worth tens of thousands per month or could turn Social Security into a welfare program rather than an entitlement.
5. The payroll tax rate could go up
Rather than selectively taxing only some individuals, another solution would be to raise the payroll tax rate for everyone. Unfortunately, tax hikes would have to be fairly substantial.
If they happen now, they'd need to go up 3.14 percentage points, from 12.4% to 15.54%. And if they don't go up until Social Security's trust fund runs short in 2035, an increase of 4.13 percentage points would be needed, meaning the new tax rate would be 16.53%.
While these taxes are split between employees and employers, with each paying half, such big tax increases might be politically difficult (and self-employed individuals would have to cover the entire tax hike themselves).
6. Higher earners could see smaller benefits
Means-testing benefits and reducing or eliminating them for higher earners would mean less money coming out of the trust fund. Unfortunately, it would again change the fundamental nature of Social Security and could make the program more vulnerable in the future if it loses support from a sizable percentage of politically active individuals.
7. The benefits formula could change
Currently, Social Security benefits are determined based on average wages in the 35 years your earnings were highest. But one option to shore up the program would involve expanding the number of years included in the calculation, up to as many as 38 or 40 years.
This option would mean more people would have years of $0 wages or years of low earnings factored in, thus reducing their average wage. It's also a benefits cut and would be especially damaging for lower-income workers in physical jobs that they often can't do later in life.
How will lawmakers fix Social Security?
It's not clear whether any of these proposals will ever become law, or whether several of them may make their way into a compromise bill. What is clear is that the next election could decide the fate of Social Security. So be certain to understand how each candidate suggests shoring up the program, because lawmakers are running out of time to find a fix.