Recent polls show that a majority of Americans have lost faith that they will receive their promised Social Security benefits in their entirety. Predictably younger adults expect to receive no benefits at all when they retire. Do financial experts believe that these dire predictions are realistic? It depends on who you ask, but most would agree there is good reason to be concerned about Social Security's financial health.
The Social Security Act was signed into law in 1935 under President Franklin D. Roosevelt. It established two national social insurance programs; old-age retirement benefits for workers in private industry and unemployment benefits for those who had lost their jobs. In large part these programs were a response to the devastating effects of the Depression which had decimated much of the lifetime savings and job opportunities for older workers.
The scope of this program was broadened in subsequent years through amendments including those adding benefits for disabled workers, dependents of retired and deceased workers, and cost of living adjustments tied to the Consumer Price Index to offset the effects of inflation.
Social Security was designed to be a pay-as-you-go system, where the money raised by payroll taxes on workers is paid out to beneficiaries. Social Security benefits are funded primarily by the 12.4 percent (shared evenly by employer and employee) tax on our earnings from work. A portion of the payroll tax is used to pay current benefits, and the balance is invested in the Social Security Trust Fund
which consists of government bonds earning interest to help pay benefits in future years.
In prior years there were more working people contributing to the system than retirees collecting benefits, generating cash flow surpluses for Social Security. Currently, our population is aging and the ratio of retirees to workers is increasing. People are also living longer in retirement and the liability to pay more beneficiaries for longer periods is spread among a smaller number of workers presenting significant challenges to the system.
According to projections by the Congressional Budget Office (CBO) released last year, starting in the 2010-2011 time-frame, Social Security is expected to operate with a cash flow deficit. By 2024 benefit costs are expected to exceed Social
Security’s tax revenues and bond income. As a result the program will need to begin selling bonds from the Trust Fund to pay benefits. In 2037, the Trust Fund will be depleted. At that point, with no bonds left, and with only payroll taxes to rely on, Social Security will only be able to pay about 75 cents on the dollar, with the shortfall growing quickly thereafter.
One excellent source of information that addresses the financial problems facing Social Security and some proposed solutions is The Social Security Fix-It Book
written by The Center for Retirement Research at Boston College. It states “The only two ways to fix the problem are to cut benefits or increase revenues, and the longer we wait, the larger the benefit cut or tax increase needed to fix the problem".
The researchers propose various ways that benefit cuts could be accomplished and
the implications of each approach including immediate across-the-board cuts for current and future beneficiaries, raising the age we can claim benefits to more
accurately reflect the trend toward longer life spans, or reducing the amount
of the cost-of-living adjustments to benefits. They go on to suggest that revenues could be raised by either increasing the payroll tax above the current 12.4% tax rate, or raising the amount of each worker’s income that would be subject to the payroll tax. Higher income earners would have more of their pay subject to the tax.
The Bottom Line
Whether our government chooses one of these solutions or those proposed by other experts, the message is clear. The sooner we take action the less drastic the measures will need to be.
This blog is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.