Social Security has a substantial funding gap. According to its trustees' best projections:
- Its Disability Insurance Trust Fund will run out of money next year.
- Its Old-Age and Survivors Trust Fund will empty in 2034.
- If those two trust funds are considered together, they would be empty by 2033.
If nothing is done legislatively to fix the funding gaps, benefits will be cut to a level that can be covered by the program's tax revenue, with total benefits dropping somewhere in the neighborhood of 23%.
Those years are crucial to recipients depending on Social Security to cover their costs of living. But a different year will likely mark the true start of the Social Security funding crisis: 2020. If nothing changes, that's the year when funding Social Security will take on a whole different level of importance to our elected leaders in Washington, D.C.
Why 2020 matters so much
To quote the Social Security Administration itself: "Social Security's total expenditures have exceeded non-interest income of its combined trust funds since 2010. ... Since the cash-flow deficit will be less than interest earnings through 2019, reserves of the combined trust funds will continue to grow. ... After 2019, Treasury will redeem trust fund asset reserves to the extent that program cost exceeds tax revenue and interest earnings until depletion of combined trust fund reserves in 2033."
Or in other words, if nothing changes:
- Before 2010, surplus Social Security taxes bought Treasury bonds, helping finance the national debt.
- Between 2010 and 2019, Social Security is fairly neutral, as taxes plus interest on the bonds held by Social Security allow it to avoid actively cashing in its Treasury bonds.
- Between 2020 and 2033, the Treasury Department must redeem bonds held by Social Security. Unless there is a sufficient federal budget surplus, it will have to borrow from somewhere else to pay back Social Security, on top of any borrowing it will have to do to cover ordinary operations.
- In 2033 and beyond, Social Security goes back to being net neutral to the Treasury, once it runs out of bonds to redeem and can only pay what it collects from taxes.
Based on the trustees' projections, the combined trust funds will top out at about $2.9 trillion in 2019. That is $2.9 trillion in U.S. national debt that had been held by Social Security but will need to be refinanced by the Treasury over the time period Social Security draws down its trust funds. Refinancing starts in 2020, and Treasury will be forced to place that debt without being able to rely on the formerly willing buyer that were the Social Security trust funds.
What it means to you
First, it means that despite the political grandstanding around the Social Security Disability Insurance Trust Fund, chances are that particular will simply be kicked down the road. The presidential election is next year, and it is incredibly unlikely that either major party wants to be painted as the one that "throws the disabled off a cliff." The "tweak" of once again shifting tax rates from the Social Security retirement fund to the Social Security disability fund can put off that day of reckoning and make it the next Congress' and president's problem.
Second, it means interest rates are likely to rise in the next few years, as Treasury must make that additional debt more attractive to public buyers. While all $2.9 trillion won't need to be refinanced at once, Treasury essentially has 13 years to resell the debt formerly held by Social Security. That works out to about $223 billion in additional debt per typical year above and beyond any new debt needed to finance any general deficit spending by the federal government.
Third, it means any push for either a more significant patch or a substantial reform to Social Security will take on a new sense of urgency in 2020, once the debt refinancing starts. It's at that point that Social Security becomes a net drain on the government's coffers, so lawmakers will have extra incentive to get past their party differences and agree on some sort of longer-term next steps.
What you can do about it
First, with interest rates likely to rise, now would be a great time to pay off what debt you can and lock in low rates on any longer-term debt that will stick with you past 2020. Mortgage rates in particular are linked to Treasury rates, and the more upward pressure on Treasury rates, the more upward pressure there will be on mortgages and other consumer-facing debt rates.
Second, regardless of how lawmakers try to patch Social Security's shortcomings, realize that even if it were completely healthy, it would only cover about 40% of a typical retiree's pre-retirement income. If you want a comfortable retirement, you'll likely need to save money to cover what Social Security won't.
When an eventual fix comes, history suggests it will contain some combination of benefit cuts and tax hikes. The money you should already be saving to cover that Social Security gap will make it easier for you to handle any tax hikes that affect your working years or any benefit reductions that impact your retirement.
Finally, even if nothing changes, as the Social Security trust funds empty, benefits won't be completely eliminated. The Social Security trustees' best estimates are that the program will still be able to pay out roughly 77% of near-term benefits after those trust funds empty, and about 72% of benefits over the long run. While that's not what you might have anticipated, it's still substantially better than $0.
Get started now
Every day brings us closer to the day of reckoning for the Social Security trust funds. You can't control what lawmakers do (or don't do) to patch up the program, but you can control how you prepare for the consequences of any adjustments they make. The sooner you get started, the better prepared you'll be, and there's no sooner time to start than today.
Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.