Social Security is a vital social program that helps ensure millions of retired and disabled Americans, as well as survivors of deceased workers, have enough income to take care of themselves.
According to the Social Security Administration, or SSA, Social Security income is designed to replace about 40% of the average worker's income in retirement. In short, the average worker should plan to have additional sources of income available when they retire, including retirement and investment portfolios, to help bridge the difference between what they earned annually when they were working and what they're now being paid in Social Security benefits.
On a relative basis, Social Security provides its biggest benefits to low-income beneficiaries. The SSA's latest data from November shows that low earners receive about 55% of their pre-retirement income via Social Security benefits. By comparison, a median earner or a maximum earner receive 41% and 27% of their pre-retirement income, respectively, from Social Security.
Social Security as we know it is changing
But Social Security is also rapidly evolving. As baby boomers begin to retire in increasing numbers, there will be a dramatic surge in beneficiaries and a drop in the worker-to-beneficiary ratio. Put another way, the Old-Age Survivors and Disability Insurance Trust (OASDI) will be paying out more money than it's bringing in via payroll taxes.
Another major shift is that we as a nation are living longer than ever. The latest statistics from the Centers for Disease Control and Prevention show that we're living to the ripe old age of 78.8, up from an average of 70 years of age five decades ago. A longer life means more time with family and friends, and it also means a longer period of time with which to collect Social Security benefits.
What all of this means is that change is coming. There's a chance it may not come during our lifetime, but it's very likely that Social Security now won't look anything like the Social Security program that your grandchildren will benefit from. Let's take a quick glimpse into the future and guess what Social Security may look like for them.
What Social Security may look like for your grandchildren
The most pressing issue for the OASDI, which is comprised of the Old-Age and Survivors Trust Fund and the Disability Insurance Trust Fund, is that it's on a path to burn through its cash reserves by 2033. This, as mentioned above, is a direct result of a major demographics shift and longer lifespans.
A common misconception about Social Security is that once these cash reserves are depleted the OASDI will then be insolvent, which isn't the case. Workers will continue to owe Social Security payroll taxes, and money will still be coming into the SSA for distribution to beneficiaries. The difference, assuming nothing is done by Congress, is that the benefits themselves will be cut by 23% in order to prolong the ability of the SSA to make payments to eligible beneficiaries.
Cutting full retirement age benefits from 100% to 77% would allow the OASDI to maintain payments at the 77% level through 2087, or an additional 54 years. In 2087 the OASDI would again need another benefits cut in order to continue making beneficiary payments due to a growing number of eligible retirees. With 59 million workers covered by OASDI in 2014, the SSA estimates that by 2090 between 105.8 million and 111.7 million beneficiaries will be covered by the OASDI, and the worker to beneficiary ratio could dip as low as 1.5 from the 2.8 recorded in 2014.
For Americans born after 1960, the full retirement age, or the level at which you're entitled to 100% of your Social Security benefits, will be 67 years. Thus, based on the average retired workers' monthly benefits of $1,328 in January, your grandchildren, assuming nothing is done by Congress, will probably be looking at a full retirement payment of $1,023 in today's dollars.
Two paths to improve Social Security for your grandchildren
A 23% cut in Social Security benefits certainly isn't preferable for existing retirees, pre-retirees, or even your grandchildren, but doing nothing and cutting benefits is one of the 12 Social Security fixes that the Center for Retirement Research at Boston College has proposed.
In total, there are around a dozen different ways to "fix" Social Security -- although the word "fix" is being broadly interpreted, and includes the aforementioned example where cutting benefits extends the life of the OASDI payouts an additional 54 years.
All told, there are two primary ways to fix Social Security. Congress can choose to either take the path of cutting benefits, which tends to anger any and all retirees and pre-retirees, or boost revenue generation, which peeves the working class that supports America's retired and disabled workers. There's obviously no perfect solution, otherwise we'd have one already -- but there are plenty of intriguing options or combinations that could work.
In terms of benefits, one idea has been to boost the full retirement age even higher. People are living longer, healthier lives, so it might make more sense to push off the age at which retirees can lay claim to 100% (or more) of their entitled Social Security benefits. When your grandchildren retire, at least based on the current full retirement age schedule, they can collect 100% of their qualified benefits at age 67. As pure postulation on my part, I could see this figure rising to age 70 by 2087, which would encourage people to work longer, providing more payroll tax income and giving workers more chance to save and invest their money, thus hopefully making them less reliant on Social Security income during their retirement.
Other intriguing options exist on the tax side of the equation. One possible solution is to increase the payroll tax for everyone, meaning workers and employers would simply have to pay more of their wages into the Social Security program. The self-employed, which pay both the employer and employee components of the payroll tax, would face double the hit.
A more popular option is to simply raise the payroll earnings cap. In 2015 nothing earned beyond $118,500 is considered taxable by the Social Security payroll tax. Thus, while a vast majority of workers are paying into the program the entire year (since they won't reach $118,500 in wages), a number of upper-income people only have a portion of their earnings hit by the payroll tax. Boosting the payroll tax earnings cap would affect only a small percentage of the population, but it could certainly help close the funding gap in the OASDI.
One lesson to learn
In reality, none of these solutions is perfect by itself. More than likely we'll need some combination of tax increases and benefits concessions in order to make the Social Security program thrive for current retirees, their children, and eventually their grandchildren.
There's certainly time for lawmakers to fix the problem, but if there's one lesson to be learned from Social Security's woes it's that you should be saving money and investing for the long-term so you (and your grandchildren) won't have to worry about Social Security providing the majority of income after retirement.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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