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Social Security Reform: How Can The Program Be Saved?

By Matthew Frankel, CFP® - Mar 7, 2016 at 7:25AM

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There's no denying it -- Social Security is running out of money. The good news it that it can be fixed, and there are a few options that could work.

Source: FDR Presidential Library & Museum

There are plenty of opinions on Social Security, but one thing is certain -- Social Security is unsustainable, at least in its current form. According to the latest report by the Social Security trustees, the trust funds will be completely depleted in 2034, at which time the only money available to pay out benefits will be the payroll taxes coming in. This is expected to cover about three-fourths of promised benefits, so something clearly needs to be done if we want to fulfill our promises to seniors. When it comes to fixing Social Security, there are two main options -- cut benefits or increase taxes.

Ways to cut benefits
Across the board benefit cuts are extremely unpopular on both sides of the political spectrum -- after all, both democrats and republicans rely on Social Security for retirement income. However, there are other ways to cut back that could help with the shortfall.

  • Increasing the minimum retirement age -- For people born after 1960, the full retirement age for Social Security will be 67. Reduced benefits are available as early as age 62 for those who want to retire early. By gradually increasing the retirement age to 68, or even 70, it could help bridge the gap. However, this could be a challenge politically, as a study by the National Academy of Social Insurance and Greenwald & Associates found that 65% of the population opposes increasing the normal retirement age past 67.
  • Using more working years to calculate benefits -- Currently, Social Security benefits are determined by an inflation-indexed average of a worker's 35 highest-earning years. By taking more years into account, say 38 or 40, it would add more years to the low end of the calculation and would drag down the wages that benefits are based on.
  • Cutting benefits for high-income individuals -- Social Security benefits are already weighted in favor of lower-income workers. By further reducing the amount of Social Security benefits that go to the people who need them the least, it could save some much-needed money.
  • Slowing down cost-of-living increases -- Cost-of-living increases are designed to help retirees keep up with inflation, and are currently based on the consumer price index (CPI). By switching to a slower-growing index like the "chained" CPI, it could save considerable money over the long term. This is likely to be an uphill battle, as the NASI survey projects that this would only solve 20% of the shortfall and would be opposed by more than three-fourths of the population.

Most republicans are in favor of some type of benefit cuts, and there are variations of each of the above solutions being discussed by the presidential candidates. Keep in mind that since both sides of the political spectrum rely on Social Security, some of the possible solutions have broad bipartisan support.

Increasing taxes is a popular solution
If we don't want to change benefits, the other way to eliminate the shortfall is to increase Social Security taxes. As of 2016, 6.2% of the first $118,500 in earned income is paid as Social Security tax by both the employer and the employee -- so 12.4% in total. And, just as with the benefit cuts I discussed earlier, there are several ways this could happen.

  • Gradually increasing Social Security taxes -- Immediate payroll tax increases are unpopular, and are unlikely to gain any serious political support, but an increase of either 1% or 2% of income phased in over a decade or more could be a possibility. A relatively painless increase of the payroll tax to 7.2% phased in over 20 years would take care of more than half of the shortfall, and is supported by 83% of survey respondents.
  • Raise or remove the wage cap -- Since only the first $118,500 of income is taxed for Social Security, there is a lot of potential revenue to be had by taxing more of high earners' income. Eliminating the wage cap altogether over a 10 year phase-in would knock out 74% of the shortfall and is supported by 80% of the population -- including 76% of those earning more than $100,000.

A third option?
There could be a third option which hasn't been talked about much -- increase Social Security revenue without raising payroll taxes by simply diverting other money into the program. For example, one candidate has suggested that we should reduce our foreign aid to potentially hostile countries, and instead direct that portion of the budget into Social Security's coffers.

This is indeed an interesting idea, but is unlikely to take care of the shortfall all by itself, so it would need to be used in conjunction with other reforms. Even so, the possibility of maintaining Social Security's solvency without major benefit cuts or tax increases could become quite popular.

What's likely to happen
History indicates that something will be done to fix the system. And, it's likely to involve a combination of the options discussed here. Certain measures, such as across-the-board cuts, are unlikely to get any serious political momentum, but as we've seen, there are some options that are quite popular.

Whatever happens to Social Security, keep in mind that the presidential candidates' Social Security plans should be taken with a grain of salt. Whatever reforms are ultimately chosen will have to go through Congress, and it's unlikely that our next president will completely get his or her way.

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