For many, Social Security is a vital financial lifeline during their retirement. Over the 20 years that national pollster Gallup has surveyed retired Americans to gauge their reliance on America's top retirement program, no fewer than 80% have responded that they're dependent, in some capacity, on Social Security income to cover their expenses.
But in spite of the clear-cut importance Social Security plays for the financial well-being of retirees, the program finds itself in trouble -- and it's retirees that could end up paying the price.
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Social Security benefit cuts could be just over a decade away
Since retired worker benefits began in 1940, the Social Security Board of Trustees has released an annual report that examines, in detail, the program's finances and outlook. Although outlooks are subject to change, the Trustees Report takes into account changes to fiscal policy, as well as an abundance of demographic shifts, to predict how financially stable Social Security will be over the coming 75 years (what the Trustees refer to as the "long term").
The 2022 Social Security Board of Trustees Report echoed a claim that's been made every year since 1985: the program has an estimated long-term deficit. Specifically, there's a $20.4 trillion funding shortfall through 2096.
Now, to be 100% crystal clear, Social Security can't go bankrupt or become insolvent. It generates 90% of its revenue from the payroll tax on earned incomes (wages and salary) and brings in additional revenue from taxing benefits on individuals and couples earning above preset thresholds. As long as Americans keep working, there is always money coming into the program for disbursement to those who are eligible for a benefit.
However, if lawmakers fail to amend Social Security and fix what ails it, the Board of Trustees opine that a sweeping benefit cut of up to 23% may be needed by 2034 to sustain payouts for the Old-Age and Survivors Insurance Trust Fund (OASI) through 2096. The OASI is the trust responsible for doling out monthly checks to nearly 49 million retired workers.
In February 2023, the average monthly check for these retired workers was $1,830.66. If the conservative assumption is made that Social Security's cost-of-living adjustment (COLA) -- i.e., the "raise" passed along most years to account for the effects of inflation -- grows by an average of 2% annually through 2034, this average retired worker should be bringing home $2,276.20 per month in 2034. A 23% reduction to this payout would slash average retired worker benefits by $523.53 per month, or $6,283 per year.
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The no-fluff reasons Social Security is struggling
You might be wondering why Social Security finds itself staring down a greater than $20 trillion funding shortfall. I can assure you with 100% certainty that it has nothing to do with "Congress stealing money from the trusts" or "undocumented workers being paid." These are prominent internet myths that have no substance to back them up.
There is, however, a confluence of factors that have contributed to Social Security's struggles.
A lot of readers are probably aware of the ongoing retirement of baby boomers. The post-World War II spike in births was a positive for Social Security for decades. But now that these folks are retiring, the worker-to-beneficiary ratio has been falling.
What might be a bit less obvious is that longevity has climbed substantially since Social Security payments began. In 1940, the average life expectancy in the U.S. was around 63 years. As of 2021, it was a little over 76 years. Comparatively, Social Security's full retirement age -- the age where an eligible beneficiary can receive 100% of their payout -- has risen just two years, from age 65 to 67. The program was simply not designed to pay retired workers for multiple decades.
Demographic shifts have played a big role in this estimated $20.4 trillion funding shortfall. For example, net-legal immigration into the U.S. has plummeted over the past quarter of a century. People that legally immigrate to the U.S. tend to be younger, which means they'll spend decades in the labor force contributing to the payroll tax that keeps Social Security functioning. Fewer legal immigrants entering the U.S. is another strain on the worker-to-beneficiary ratio.
Additionally, the U.S. fertility rate has hit historic lows. This is due to a combination of couples waiting longer to get married and have children, better access to contraceptives, fewer unplanned pregnancies, and possibly economic concerns (e.g., bringing a baby into the world during a pandemic or recession). Not to sound like a broken record, but fewer babies being born means a decline in the worker-to-beneficiary ratio is forthcoming years down the line.
There's also a growing income inequality problem affecting Social Security. Even though the amount of earned income subject to the payroll tax increases most years, the percentage of wages and salary above and beyond the maximum taxable earnings cap has grown pretty substantially over the past 40 years. Well over $1 trillion in earned income isn't subject to the payroll tax each year.
Historically low interest rates have weighed down the yields of the special-issue Treasury bonds held by Social Security. Effective Federal Funds Rate data by YCharts.
The Federal Reserve deserves its share of the blame, too. A decade of historically low lending rates hurt the interest income-earning capacity of Social Security's asset reserves. The more than $2.8 trillion the program currently has in its asset reserves is required by law to be invested in special-issue Treasury bonds.
Lastly, blame lawmakers. Once again, Congress didn't raid Social Security's coffers or steal funds in any way. Every cent of the program's asset reserves is accounted for by the special-issue Treasury bonds.
The issue with lawmakers is they continue to kick the tires when a seemingly endless series of solutions have been presented to strengthen Social Security. Since 60 votes are required to amend Social Security in the Senate, bipartisan cooperation is a must. Unfortunately, getting Democrats and Republicans to agree on amendments while approaching those fixes from opposite ends of the spectrum hasn't worked.
For what it's worth, Congress does have a history of stepping in and saving Social Security from possible benefit cuts. Lawmakers most recently did this in 1983, when gradual increases to the payroll tax and full retirement age were announced, and the taxation of benefits was introduced. But given Capitol Hill's penchant for 11th-hour legislation, a fix could be a long way off.
If there's no discernible change in these aforementioned demographic shifts, and lawmakers continue to shun bipartisan cooperation, an estimated $6,283 benefit cut could be the end result by 2034 for the average retired worker.
