Melissa A. Seamon, CFP®
Senior Financial Advisor
Gen X and younger generations fear that Social Security retirement benefits will be obsolete by the time they reach retirement age. This is, of course, unfair because they are paying into the program. Given the program’s outlook, this is a reasonable concern. Even though Social Security likely won’t comprise a huge portion of your retirement income, it’s important to know the current and projected financial health of Social Security, what the exact problem is, and what solutions are available right now. While it’s difficult to know what lies ahead, this information can help construct a picture of where Social Security is heading.
The Condition of Social Security’s Finances
The Social Security program’s expenditures include all retirement, survivor, and disability benefits. In 2017 the program had a surplus, and in 2018, a sizable cash reserve of 2.9 trillion. However, in 2021 the Social Security Administration (SSA) reported that the program’s funds had been significantly affected by the 2020 pandemic and recession.
According to the SSA report, The Old-Age and Survivors Insurance Trust Fund (OASI), which pays retirement and survivors benefits, will be able to pay scheduled benefits on a timely basis until 2033 (last year it was 2034). At that time, the fund’s reserves will be exhausted, and social security tax income will be enough to pay only 76 percent of scheduled benefits.
However, for the time being, Social Security’s reserves remain in good shape. Those who are receiving or anticipating a Social Security income may almost certainly rely on it. The issue is, how long will this last? According to the current research, younger Americans may find themselves in financial difficulty down the road if they do not start preparing now.
A Downward Spiral is to be Expected
Future Social Security shortfalls were predicted pre-pandemic, but no one anticipated the impact of the pandemic and 2020 recession on the economy. This includes a detrimental blow to employment, income, interest rates, and GDP. Social Security benefits are predicted to surpass incoming payroll taxes, Social Securities’ funding source, and investment returns by $3 trillion in the next 11 years, meaning SSA will have to draw heavily on its reserves.
SSA will be able to pay benefits even if no changes are made before 2033. However, the best outcome would be for the SSA to act now to prevent this deficit. The reality is that unless extensive changes are made, cuts will become necessary by 2033. But how realistic and attainable are these changes?
What Exactly is the Issue?
Why is Social Security’s financial situation projected to deteriorate so quickly? Despite the pandemic and 2020 recession, the SSA is, after all, responsible for the most important retirement program in the U.S.
SSA funding in the coming decades will be affected by two key factors. One, longer life spans due to medical and technological advancements, and two, mass retirement. Most Baby Boomers and even some members of the Gen X generation will be retired by 2033. This leaves Millennials and Gen Zs financially vulnerable when relying on Social Security alone.
Because of lower birth rates in all generations following the Baby Boomers, more people will be leaving the workforce than entering in the coming years. The implications here are that there will be far fewer individuals contributing to Social Security than is needed to support the program.
So, what are the options for resolving the issue?
SSA’s most feasible possibilities involve revenue hikes or benefit reductions. Over the next 70 years, the budget deficit for Social Security will be almost $13.5 trillion (in current value). According to the Social Security Administration, a 2.78 percent rise in payroll taxes may cover the deficit over the next few years. Many businesses and employees, on the other hand, are wary since this would require them to divide the extra cost of payroll taxes. Businesses pay one half of the payroll tax and employees pay the other half. While 2.78 percent may not seem like much, this increase equates to a 1.39 percent tax hike on up to $128,400 in earned income for every American.
A different option would be to eliminate the taxable income ceiling. That is, all earned income, no matter how small, will be subject to taxation. According to research by the National Academy of Social Insurance, this could close the 76 percent budget shortfall. However, students, new businesses, independent contractors, self-employed persons, part-time workers, and anybody who does not match the standard work situation could be significantly impacted if this happened since they pay 100% of the payroll tax.
A combination of these two solutions will likely be used.
In this light, the most likely solution to remedy the deficit would include a combination of benefit reductions and revenue increases (phased in over time). What is certain is that a big tax increase or benefit removal is unlikely to happen in the foreseeable future.
Alternative ways to fix Social Security may include:
- Utilizing estate tax revenue to help fund Social Security (leading to potential federal deficits).
- Privatization of Social Security (invested in private retirement accounts).
- A one-time buyout for wealthy individuals (a one-time cash payment for those who don’t really need Social Security).
- Allowing student loan borrowers to raise their full retirement age in exchange for student loan forgiveness (would take care of about 11% of the funding gap).
Don’t Worry if You’re Retired or About to Retire.
While this scenario is troubling if you’re ready to retire or are 50 years old or over, you shouldn’t be concerned. The Millennial and Gen Z generations are the ones that need to start planning now. There are no provisions in any of the credible Social Security programs that would affect existing retirees or those who will retire shortly. The ability of older Americans to keep their benefits looks to be robust.
Finally, it’s worth noting that this isn’t the first time Social Security has run into financial difficulties. In the 1970s, Social Security’s financial status resembled that of today. Benefits were simply not covered by revenue. While Congress delayed until the last minute to act, President Ronald Reagan signed the Social Security Amendments of 1983 into law on April 20, 1983, and the reform package (income-taxed benefits) countered the progressive rise in the full retirement age.
While this reform package did not completely fix Social Security’s financial concerns, it did prolong the trust fund depletion date from 1983 to 2034, a 51-year extension.
Will Social Security Be Available When I Retire?
Most Americans, regardless of age, economic level, or political party believe that Social Security is a vital aspect of this country and should be preserved without many cuts. But there is no guarantee that it will last.
Will payroll taxes be increased, or will the Social Security tax be applied to a larger percentage of high-income individuals? Will each year’s cost-of-living adjustments be calculated differently? Is there going to be a change in the formula for calculating benefits? In the next 12 years, policymakers will have to answer these issues and those with retirement in their sights will have to make adjustments.
For now, young professionals and those in the accumulation phase should be saving NOW for their retirement needs should we see the program only able to support reduced benefits for future generations.
If you are in need of a financial ally, we encourage you to visit our site, learn more about our services, and see if we could be a good match. We best serve clients looking for exceptional client service, who value a long-term partnership, and have a minimum of $500,000 in investable assets.
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