According to the latest projections, the Social Security Trust Fund is expected to run out of reserves in about 17 years, at which time across-the-board benefit cuts may be necessary, threatening the financial well-being of millions of American retirees. The good news is that there's still time to implement solutions that could fix Social Security and promote the financial security of future generations of retirees.
The Social Security funding gap and why tax increases are the logical solution
As I've written before, Social Security is well-funded for the time being, but this isn't expected to last too long. Specifically, the program is expected to start running at a deficit in 2020, and continue paying out more than it brings in for the foreseeable future.
According to a report by the nonpartisan Congressional Budget Office, or CBO, the long-term funding deficit is projected to fluctuate between 1.5% and 1.9% of GDP from 2027 through 2082. So, it's fair to say that the average annual deficit over the long run is expected to be about 1.7% of GDP.
25 Social Security facts & figures you need to see
25 Social Security facts & figures you need to see
1. 60.66 million
As of the September 2016 snapshot from the Social Security Administration (SSA), 60.66 million people were receiving monthly benefits, two-thirds of whom are retired workers. A little more than 6 million survivors of deceased workers and 10.6 million disabled persons were also receiving monthly benefits.
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2. 5.44 million
Social Security's beneficiary base is increasing rapidly due to the ongoing retirement of baby boomers, which is expected to last until about 2030. As such, 5.44 million people were newly awarded Social Security benefits in 2015.
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It's important to understand that Social Security isn't an entitlement, though the requirements for a guaranteed benefit are not too high. You need 40 lifetime work credits to qualify for Social Security benefits, and a maximum of four credits can be earned annually. In 2017, one work credit is equal to $1,300 in wages. Simply earn $5,200 in 2017 and you'll have maxed out your work credits for the year. Do that 10 times and you'll be guaranteed benefits when you retire.
Based on statistics from the SSA, nearly all working Americans (96%) are covered by survivors insurance protection. Though Social Security is primarily designed to provide financial protection for retired workers, it does provide benefits for the spouses, children, and in rarer cases parents of deceased workers.
To add to the above statistic, the SSA also points out that 90% of the American workforce is covered in case of long-term disability. Since nearly 70% of all private sector workers have no long-term disability insurance, it's good knowing that Social Security has their back.
An interesting figure from the SSA is that 55% of beneficiaries are women. Social Security income is of particular importance to women since 1) they tend to live about five years longer than men, on average, and 2) they're often the caregivers that take care of the kids or sick family members, thus their lifetime earnings are often lower than their male counterparts'. Social Security income can be critical to ensuring a healthy financial foundation for women come retirement.
According to an analysis conducted by the Center on Budget and Policy Priorities (CBPP), Social Security income has reduced what would be a 40.5% poverty rate for seniors without this added income to just 8.5%. While the CBPP's analysis can't factor in external variables such as how much extra seniors would have saved prior to retiring if Social Security wasn't available, it's clear as day that Social Security is critical to keeping seniors on solid financial footing.
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Based on data from the SSA, 81% of all benefits paid out by the Old-Age, Survivors, and Disability Insurance Trust (OASDI) are heading to seniors ages 62 and up. Just 5% go to children under the age of 18, and another 14% to adults between the ages of 18 and 61.
Statistics from the SSA in 2016 show that 61% of seniors rely on Social Security to provide at least half of their monthly income. For elderly couples this figure was 48%, while 71% of unmarried elderly persons lean heavily on the program for at least half of their monthly income.
10. $920.2 billion
The SSA's data showed that $920.2 billion was collected from three revenue channels in 2015. A majority of this revenue came from payroll taxes (86.4%), while interest earned on the OASDI's spare cash (10.1%) and the taxation of benefits (3.4%) comprised the remainder.
Payroll taxes comprise the lion's share of revenue collection for Social Security. This tax totals 12.4% of wages (up to a certain point, which is discussed below) and it's typically split down the middle between you and your employer, with each paying 6.2%. If you happen to be self-employed, you're on the line for the entire 12.4% tax.
There is, however, a cap on how much a person can be taxed by the SSA via the payroll tax. All earned income in 2017 between $1 and $127,200 is subject to the 12.4% payroll tax. Any wages beyond that point are free and clear of being taxed by the SSA.
The September 2016 snapshot shows that the average retired worker is bringing home $1,351.70 per month, or $16,220 over the course of a year. Annual benefit increases are tied to the inflation rate as measured by the Consumer Price Index for Urban Wage Earners and Clericals Workers, or the CPI-W.
Speaking of inflation, Social Security beneficiaries are getting a 0.3% cost-of-living adjustment (COLA) in 2017, the smallest increase on record. Social Security's COLA has been dragged down in recent years by weaker energy and food costs, which are sizable components of the CPI-W.
15. 33 out of 35 years
One of the more saddening facts and figures about Social Security is that its COLA has been lower than medical cost inflation in 33 of the past 35 years. The CPI-W factors in a number of varied expenses, but medical costs are a much smaller portion of workers' average expenditures. Seniors spend double what urban wage earners and clerical workers do on medical costs as a percentage of their annual expenditures.
Social Security benefits are capped at $2,687 per month, which makes sense given that payroll taxes have an annual cap as well. The monthly benefit cap is usually adjusted year-to-year based on inflation. Only a small fraction of Americans have a shot at reaching this maximum payout, as you'll see in the next figure.
Based on data from 2013, as assembled by the Centers for Retirement Research at Boston College, 60% of retirees sign up for benefits before reaching their full retirement age (FRA). A person's FRA is when they become eligible to receive 100% of their FRA benefit. By signing up early, retirees are taking a cut in benefits from their FRA benefit of up to 25% to 30%.
As of 2015, the worker-to-beneficiary ratio stood at 2.8 workers for every one beneficiary. In about two decades, this ratio is forecast to drop to 2.1-to-1. In simpler terms, baby boomers are retiring in increasing numbers, and there simply aren't enough new workers to take their place and maintain the worker-to-beneficiary ratio at its current level. This leads to the next point…
20. The year 2020
Based on the latest report from the Social Security Board of Trustees, by 2020 the cash inflow into the OASDI is slated to turn into a cash outflow. In other words, what's expected to be close to $2.9 trillion in spare cash will begin dwindling in 2020.
21. The year 2034
Perhaps the scariest finding of the Trustees' report is that Social Security's spare cash is expected to be exhausted by the year 2034. Assuming Congress passes no new laws affecting Social Security, the Trustees predict that an across-the-board benefits cut of up to 21% may be needed to sustain payouts through the year 2090.
Findings from the Board of Trustees report also showed that the actuarial deficit in 2016 was 2.66% for the program. In easier-to-understand terms, a 2.66% increase to the payroll tax would be expected to alleviate all funding concerns through the year 2090. This would mean an increase to 7.53% if you're employed by someone else, or 15.06% if you're self-employed.
It's a fact that gets overlooked by many seniors, but Social Security income may be taxable. Individuals earning more than $25,000 annually and joint filers with income over $32,000 could have a percentage of their Social Security benefits taxed. Not to mention 13 states also tax Social Security benefits.
According to Gallup, 51% of polled Americans in 2015 believed Social Security won't be there for them when they retire. Luckily, this is blatantly false. Social Security is essentially incapable of going bankrupt because it'll always be collecting payroll tax revenue from the workforce. Benefits may indeed need to be cut, but the program will be there for many generations to come.
Finally, a survey conducted by MassMutual Financial Group in 2015 found that just 28% of the more than 1,500 respondents who took its quiz received a passing grade and correctly answered at least 7 out of 10 multiple choice or true/false questions. Only 1 respondent out of more than 1,500 got all 10 questions correct. It's a stark reminder of just how little Americans know about Social Security.
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There are two ways to fix the problem — raise taxes or cut benefits — and there are dozens of options within those two categories. However, studies have shown that the vast majority of Americans of all ages, income levels, and political affiliations are opposed to Social Security benefit cuts in any form. Plus, according to the same CBO report, most forms of benefit cuts won't have much of an impact on the funding deficit all by themselves.
Tax increases, by contrast, are not just a more popular way to fix Social Security among the American public, but several of the options that have been proposed have the potential to make a big impact on Social Security's funding problem. In fact, by making just two tax changes, Social Security's solvency could be secure for at least the next 65 years.
No. 1: Gradually increase the payroll tax
The first change involves increasing the Social Security portion of the payroll tax. As it stands now, Americans pay 6.2% on all earned income (wages, salaries, and self-employment), up to a certain maximum each year. Employers match these contributions, so a total of 12.4% of salary is being contributed per worker (for most of us — we'll talk about the exception shortly).
By increasing the Social Security payroll tax by 2 percentage points on both workers and companies over a 10-year period, we could increase Social Security funding by 0.6% of GDP. In other words, the current rate would increase to 6.4% in the first year, 6.6% in the second year, and so on, until the employee and employer rates had risen to 8.2% of taxable payroll.
No. 2: Tax all wage income
The second change involves the Social Security wage base — the ceiling above which annual earnings are exempt from the payroll tax. This is adjusted each year, and currently sits at $127,200. This means a person pays 6.2% into Social Security on all their earnings up to this amount — if you're fortunate enough to to have earnings above this threshold, they're not taxed for the program at all.
Eliminating this taxable wage cap altogether would add 1.1% of GDP to Social Security's revenue, bringing the total addition to 1.7% when combined with the higher payroll tax mentioned previously. And that, as you'll recall from the beginning of this article, is precisely the size of average annual deficit the program is expected to run.
Here's the catch. If those changes are to fill the hole completely, we would have to eliminate the taxable wage base without increasing benefits. Right now, just as there's a cap on how much one can pay in each year, there's a cap on benefit levels to match. Presumably, many wealthier Americans who would be paying more into the system would want to get higher benefits in return, so eliminating one without altering the other is a policy move that might face significant opposition from the 6% or so of Americans whose incomes top that ceiling. However, it's worth pointing out that eliminating the taxable maximum while also increasing benefits would still help significantly — but additional changes would still be required.
Studies show that most Americans would be fine with these changes
You might expect that tax increases would be unpopular among the American public, particularly among Republicans and high-income households. However, when it comes to these hikes, that doesn't appear to be the case.
According to a survey by the National Academy of Social Insurance, 77% of Americans feel that it is critical to preserve Social Security benefits for future generations, even if it means raising taxes. Among respondents, 81% agreed that they don't mind paying taxes into Social Security "because it provides security and stability to millions." This includes majorities of every age group, income level, and political affiliation.
The bottom line is that with a couple of tax changes, we could return Social Security to long-term solvency, and they are moves that most Americans would likely be on board with. Given that the federal government is under Republican control, they may not happen within the next few years, but it's certainly a possibility that Washington will act before the Social Security trust fund is depleted.
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