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Is This the Best Way to Fix Social Security?

By Matthew Frankel, CFP® - Apr 4, 2016 at 7:03AM

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Here are the Social Security changes favored by most Americans. Here's what they would mean to you.

Image source: American Federation of Government Employees via Flickr.

There's no denying it -- Social Security is unsustainable in its current form and will need to be fixed. According to the latest Social Security Trustees' Report, the program's trust funds will be completely depleted by 2034 based on the projected rate of money flowing in and out. Fortunately, there are several ways we can fix Social Security, and some of these solutions are rather popular among the American public.

The most popular way to fix Social Security
According to a study (link opens PDF) by the National Academy of Social Insurance, there is one package of Social Security changes that is clearly the most supported among the American people.

This package would make four key changes:

  1. The taxable earnings cap for Social Security, which is $118,500 for 2016, would be eliminated over a 10-year phase-in period, eventually making all wages taxable for Social Security purposes.
  2. The Social Security tax rate that workers and their employers pay would be gradually increased from 6.2% to 7.2% over a 20-year period.
  3. The cost-of-living adjustments given to Social Security recipients would be increased to better reflect the higher inflation experienced by seniors.
  4. The minimum Social Security benefit for someone who paid into the system for at least 30 years would be increased, to prevent any retirees from living in poverty.

At first, this might not sound like a great plan to fix Social Security -- as you probably noticed, the latter two fixes would actually add to Social Security's financial obligations.

However, the study found that eliminating the earnings cap would take care of 74% of the projected shortfall, and the increase in Social Security taxes would take care of 52%. In other words, these two changes alone would cover 126% of the projected Social Security funding gap. Meanwhile, the two increases would only add 23% to the shortfall. So, the net effect of these four changes would be that more than 100% of the Social Security funding gap is filled, and the system can remain solvent.

The study found that such a package would be supported by 71% of Americans across all generations, income levels, and political parties.

What it could mean to you
If this package of Social Security changes were to become reality, the way it would affect you depends on a few factors -- mainly your income and age. So, let's consider a couple of examples.

High-income workers would experience the most negative effect. A worker who earns $300,000 in 2016 pays a total of $7,347 in Social Security taxes. However, once the higher tax rate and elimination of the wage cap are phased in, this worker can expect their Social Security taxes to jump to $21,600 -- or nearly triple what they were before. Sure, their eventual Social Security benefit would be higher, but since Social Security is weighted toward lower-income workers, the benefit increase wouldn't be proportional to the increase in taxes.

For a middle-income worker earning $45,000 per year, the changes would be less dramatic. When the changes are fully phased in, this worker's Social Security tax would increase by $450 per year. However, the eventual cost-of-living adjustments this worker received in retirement would better reflect the actual inflation experienced by seniors, so this peace of mind could easily be worth a modest increase.

Finally, a low-income worker close to retirement age who earns an average of $17,000 per year throughout their career would see the biggest positive change. Under the current calculation method, this worker would be entitled to a Social Security benefit of $949.81 per month -- below the poverty line. If these changes were to go into effect, this retiree would be guaranteed a minimum benefit that would allow them to retire and not live in poverty, which could be well worth the $170 annual tax increase.

It's also important to mention that perhaps the biggest benefit to all workers if these changes were to happen would be the sustainability of the Social Security program itself -- and the continuation of the current retirement age.

What's most likely to happen?
Now, keep in mind that these aren't the only potential ways to fix Social Security. We could also raise the full retirement age or cut benefits for higher-income workers, just to name a couple of possibilities. However, most solutions that involve benefit cuts of any kind are strongly opposed by much of the population, and are therefore unlikely to gain any serious political traction.

Because of this, although the four changes mentioned here are unlikely to happen exactly as described, some combination of higher taxes and more earnings subject to those taxes are the most likely way that Social Security will ultimately be fixed.

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