Both current and future retirees need to be aware that time is running out before Social Security benefits could be reduced substantially. Social Security's trust fund is projected to run dry in 2035 or earlier, which means that by the time today's 52-year-olds reach their full retirement age, they could get much smaller benefits than they were promised.
How much smaller? If the trust fund is depleted and retirement benefits can be paid out of only current payroll taxes, retirees are looking at a 24% benefits cut. With the average Social Security benefit already providing just $1,503 per month, such a substantial decrease could lead to a major decline in quality of life.
The good news is there are some possible solutions to stop this from happening. But the bad news is there are really only three options -- all of which are politically unpopular. Here are the three possible fixes to Social Security's financial troubles.
1. Change the full retirement age
When Social Security was first created, full retirement age (FRA) -- the age when a retiree could receive his or her standard benefit -- was 65. The Social Security Amendments of 1983 changed FRA to 67, phasing in the change gradually. Pushing FRA back was considered a necessary part of a compromise to shore up Social Security as life expectancies had increased and people were receiving benefits for many more years.
Now some lawmakers believe history should repeat itself and FRA should again be pushed back -- perhaps to as late as 70. This would be a de facto benefit cut for everyone because it would eliminate the opportunity to increase benefits by earning delayed retirement credits. And those who don't delay retirement to the new FRA would see a smaller check due to early filing penalties.
While pushing back full retirement age would help fix funding shortfalls, there's strong opposition. And the Brookings Institution warns that gains in life expectancy have mostly occurred among high earners, so those with lower incomes would take the brunt of the hit.
2. Cut benefits
While changing FRA is a de facto benefit cut, there are other possible reductions on the table, too.
Lawmakers could change the way Social Security raises are calculated. Right now, they're determined based on changes to the Consumer Price Index for Urban Wage Earners and Clerical Workers, but that could be switched to Chained CPI instead. This is a different pricing index that assumes consumers adjust behaviors by switching the products they buy as prices go up. If this change occurred, it will help save money because benefits rise more slowly -- but with benefits already losing buying power, it could cause financial pain for retirees.
Benefits could also be cut if lawmakers change the formula used to calculate them. One proposal on the table is to determine a retiree's standard benefit by basing it on average wages from a worker's 40 highest-earning years (after adjusting for inflation) instead of 35 years, which is the current rule. This could mean more people have years of $0 wages or lower-earning years factored in.
Implementing these cuts may be easier than changing the full retirement age because they seem more like technical tweaks. In fact, they may go largely unnoticed since many people don't know the intricacies of how raises are calculated or how the benefits formula works. But, make no mistake, the cuts ushered in would have a substantial impact.
3. Raise taxes
While benefit cuts will almost assuredly be part of any plan to fix Social Security, lawmakers on the left generally would prefer to raise revenue to either keep benefits the same or to provide expanded benefits.
Taxes could be raised across the board, with the Social Security Trustees Report indicating a 3.14 percentage point increase to the payroll tax would be necessary to provide sufficient funding if implemented immediately. Most Democratic proposals, however, don't impose a tax increase on everyone but instead change the way the wealthy are taxed. Right now, workers pay taxes only up to an annual wage base limit and receive benefits based on the amount they pay in. Some proposals would require higher earners pay taxes on more of their income or even all of it -- and not necessarily get bigger benefits.
Tax increases probably won't be popular, and if they come without a corresponding increase in benefits, they'll change the way Social Security has always worked since it's always been an earned benefit.
Will Social Security find a financial fix?
Although the Social Security Trustees have been warning for years that the day of reckoning draws ever closer, lawmakers haven't been able to pass any compromise legislation addressing Social Security's serious financial flaws since the early 1980s. And with partisanship at record highs, it's unlikely they'll be able to do so anytime soon.
Lawmakers may simply throw up their hands and approve additional spending for Social Security without making any of these tough choices. But this, too, would be a fundamental change in the way the program is structured. It's also unsustainable for the long term with the country falling ever deeper into debt, and it's unclear if this idea could get majority support.
The bottom line is, without action, benefit cuts are inevitable -- and most actions will also involve cuts, too. So current and future retirees need to boost their savings, make smart investments, and make sure that they're well prepared to cope with reduced Social Security checks, as that very likely could become the reality within 15 years or less.