by Andrew Sivertsen, CFP®
I hear a number of questions and concerns around the Social Security Program from my clients. Some wonder whether the program will be intact by the time they get to retirement.
Many want to know how to optimize their benefits, and others how to better understand complex rules around spousal benefits in various scenarios. The media has a tendency to fill us with fear, and as a result there are more questions than answers regarding these topics. So much so that many Americans under the age of 50 are nervous about planning on receiving any benefits at all from Social Security. I’d like to take a deep dive into those concerns.
What is Social Security?
Social Security is the common name for the Old Age, Survivors, and Disability Insurance (OASDI) program signed into law by President Franklin D. Roosevelt during the Great Depression. The program was originally designed to help replace income lost by individuals due to old age, the death of a spouse, or disability. The program is funded from payroll taxes collected from workers’ paychecks called FICA (Federal Insurance Contributions Act) taxes. The government setup two trusts to hold the money: one for retirement and the other for disability. These trust funds pay roughly 63 million individuals over $1 trillion in benefits annually.
What is the current outlook?
Every year the Social Security and Medicare Boards of Trustees release a message to the public: https://www.ssa.gov/oact/TRSUM/. They estimate that the Old Age & Survivors Trust fund will be depleted by 2035. Once the trust fund is depleted, Social Security will not be able to pay out benefits above what they are receiving from payroll.
It is currently estimated that payroll taxes can sustain roughly 80% of benefits, and that percentage may gradually lower to 70% over the trustees’ 75-year projection. Without reform, all recipients will experience a roughly 20% reduction in benefits at that time. Analysis shows that there is still time to make adjustments today that will put Social Security on a sustainable long-term path, but it would require action by Congress. This can be done by decreasing benefits or increasing revenue. Both of which can be done in multiple ways and either method will affect retirees or workers.
What are some of the proposals to fix the program?
- Raise Payroll Taxes: Currently, employees pay 6.2% of their wages into the Social Security system while their employers match that amount. Congress could consider a gradual increase to the tax over a set number of years. For example, raising the tax that both employees and employers pay by 0.1% over the course of 20 years to 7.2% of wages.
- Raise or eliminate the tax cap: The payroll tax is currently capped at a maximum $132,900 of income, meaning that those who earn more than the cap are maxed out. Again, there are a lot of ideas on how this could be accomplished. One example would be to gradually raise the maximum tax cap to double the amount over a certain number of years. Alternatively, another example would be to leave the current tax cap in place, but reintroduce some form of payroll tax on income earned over a certain amount, say $400,000, for example.
- Increase the retirement age: The current full retirement age for individuals born after 1960 is 67 (for most baby boomers full retirement age was 66). One idea is to gradually increase full retirement age from 67 to 68 over the course of 5 years. Another would be to raise it to 70 years of age over a much longer window.
- Reduce the cost-of-living adjustment: Every year Social Security uses the Consumer Price Index to determine the rate of inflation experienced by recipients and increases benefits accordingly. One possibility would be to increase benefits by 90% of CPI, or to use a slower measure of inflation all together.
- Means-Test Benefits: This proposal is meant to limit or eliminate the retirement payouts for retirees with high income. For instance, a recipient’s benefits could be adjusted (lowered) if their non-social security retirement income was above a certain threshold.
What Do We Do Now?
There are many alternative solutions, but the ones I have mentioned are some of the bigger options being discussed right now. Know that every reader is going to react negatively to one or more of the proposed solutions, but delaying action will just further compound the problem. The reality is that we all will share in the pain of fixing a system that has become an integral part of our society. Social Security can only be fixed by coming together as a collective whole, and most likely making some combination of all the proposals.
Andrew Sivertsen, CFP®, is a Sr. Financial Planner in the Quad Cities office of The Planning Center, a fee-only financial planning and wealth management firm. Email him at: andrew@theplanningcenter.com.
