When it comes to retirement, Social Security is one of the most hotly debated issues in America, but one thing is for certain: Something will have to change for the system to survive. So how do we fix it?
We asked three of our experts how Social Security can be fixed, and here is what they had to say.
You're probably aware that your paycheck regularly gets a 6.2% haircut for "FICA," but you might not have given that much more thought. The full name is the Federal Insurance Contributions Act, and your FICA contributions go toward supporting Social Security and Medicare. Another thing that many people don't realize is that their employers kick in another 6.2%, so 12.4% of your earnings actually go into the Social Security pot. (Pity the self-employed, because they have to pay both halves -- the whole 12.4%.)
But there's an aspect of the FICA tax that displeases many Americans, and if it's changed, it could generate a lot more money for Social Security. You see, the FICA tax is levied on your income -- up to a point: There's a wage cap that's increased every year. For 2014 and 2015, it's $117,000 and $118,500, respectively. So if in 2015 you earn $60,000, all of your income will face the FICA tax. But if you earn, say, $1 million, only the first $118,500 of your income will be taxed, leaving the remaining $881,500 FICA-free. Thus while the $60,000 earner forks over 6.2% of their income, the million-dollar earner only sacrifices 0.73%.
This strikes many as unfair, as those with more limited means have to give up a greater percentage of their income than those who earn much more. It also restricts the amount of money flowing into Social Security coffers. It has been estimated that if this cap were removed, it would reduce Social Security's current financing gap by 45%. That's not a total solution, but it goes a long way toward making the system more sustainable and fair.
Fixing Social Security's projected shortfalls requires either raising taxes or cutting benefits. One controversial proposal for reducing payouts is to use means-testing to reduce Social Security payouts to wealthier retirees. Those who have income from sources other than Social Security above certain limits would see their monthly checks shrink, with benefits completely disappearing for those who earn more than a maximum threshold.
Those who favor means-testing note that lawmakers can tailor the plan so that it affects a small number of people while making substantial progress toward closing the long-term Social Security funding gap. One AARP study showed that starting to phase out Social Security for single retirees earning more than $55,000 in other income, and joint filers earning more than $110,000, would fill about 11% of the gap while affecting just 9% of all retirees. Opponents of means-testing point out that the Social Security Administration's current formula for calculating benefits already takes income levels into account, paying out a larger proportion of average earnings to low-income workers than to higher-income workers. Moreover, it penalizes savers and further weakens the link between taxes paid into the system and benefits collected from it. Nevertheless, measures that look to impose a higher burden on upper-income earners are consistent with the current political environment, so this proposed fix is something retirees and current workers should keep an eye on.
One way to fix Social Security's funding gap would be to raise both the early eligibility age and the full retirement age. Currently, the early eligibility age is 62, and the full retirement age for most prospective retirees is 66. By claiming at the full retirement age, you are entitled 100% of your social security benefits, i.e., your "primary insurance amount." That primary insurance amount will be lowered or raised depending on whether you claim before or after your full retirement age.
By raising both the early eligibility age and the full retirement age, the government would have to pay out less in Social Security benefits.
The Congressional Budget Office has only looked at each age level separately. In both cases, the CBO's estimates are based on a policy of raising the ages by two months per year. The CBO found that raising the early eligibility age from 62 to 64 would mean that far fewer people would retire at age 62, opting instead to wait until age 64. They found this would increase the size of the labor force and the economy by a little over 1%, boost federal revenue from income and payroll taxes, and lower Social Security's direct costs by 1% through 2021.
Raising the full retirement age would have a much bigger effect by itself. The CBO found that raising the full retirement age from 66 to 70, by two months every year, would lower Social Security's costs by 1% through 2021, 4% by 2035, and 13% by 2060.
Raising both ages would have a larger combined effect, especially if they were raised more quickly, perhaps by three months per year instead of only two. Supporters of this solution say it only makes sense, given that Americans are living longer, healthier lives than ever and might therefore be expected to remain in the workforce longer.
While many people fret about Social Security's impending shortfall, fixing it could be as simple as tweaking a few formulas.