David Strege, CFP®, CFA, CKA®, Senior Financial Planner
April 22, 2022
Many articles have been written about the Social Security shortage “can” getting kicked down the road. The question is, “Will this ‘can’ get smashed instead of being kicked along further?”
It is projected that the $2.9 trillion Social Security reserve will be depleted in 2033, according to the Social Security annual trustees 2021 report. This was even after an $11 billion increase to the reserve in 2021. Many experts agree that an eventual depletion is inevitable.
The scope of the problem is magnified by the fact that the number of Americans 65 and older will increase from about 57 million in 2021 to about 76 million by 2035, according to a Fact Sheet by the Social Security Administration.
However, the 2033 prediction is not the end of Social Security. When the trust is depleted, the benefit amount is reduced to pay out only what is coming in from the tax that is taken out of paychecks.
To explain further, The Old Age and Survivors Disability Insurance (OASDI) is often referred to as the Social Security tax. Both the employee and employer pay 6.2% each for a tax total of 12.4% of a person’s paycheck. If the trust is depleted and only 12.4% tax is coming in, it is projected to cause Social Security benefits to drop by 24%.
Social Security is the major source of income for most of the elderly according to a report from the Social Security Administration.
- Nearly nine out of 10 people age 65 and older were receiving a Social Security benefit as of December 31, 2020.
- Social Security benefits represent about 30% of income of the elderly.*
- Among elderly Social Security beneficiaries, 37% of men and 42% of women receive 50% or more of their income from Social Security.*
- Among elderly Social Security beneficiaries, 12% of men and 15% of women rely on Social Security for 90% or more of their income.*
*This information is from research released in 2021 using 2015 data.
With these stats, a 24% drop in benefits would cause hardship and potential chaos among U.S. retirees.
Benefits like Social Security are not unique to the United States. The Social Security Administration lists more than 170 countries that have such a program.
The U.S. Social Security Act that went into effect in 1935 followed 100 other countries that had previously instituted a similar program. While providing a financial base for retirees, the Act failed to look ahead to how it would be funded in the future. At the time it passed, benefits could be collected at age 65 but the average expected mortality was only 63. Today you can begin collecting retirement benefits from age 62 to 70 and average mortality is 77.3.
COVID-19 contributed to the decline in life expectancy from 78.8 years in 2019 to 77.3 years in 2020, according to the CDC’s National Center for Health Statistics. For more on mortality rates, click here. For more historical information about Social Security, read this article.
In the early years of Social Security, the baby boomer demographic bubble had not occurred yet which would eventually cause the ratio of covered workers to those receiving benefits to drop from 5.1 in 1960 to 2.8 in 2013. The current ratio is 2.7 and expected to drop to 2.3 by 2035. Projections estimate that a ratio of 2.8 is needed to cover payouts. For a chart listing the ratio of Social Security covered workers to beneficiaries from 1940-2013, click here.
Increases in Social Security benefit funding come from increases in the wage base. When the number of workers decrease and wages are struggling to keep up with inflation, the funding stream struggles to realize any increases.
The payment of FICA taxes isn’t a loss as many people assume. The overall return on investment for your Social Security taxes averages about 2% above inflation. This is similar to a low-risk investment mixture. The results vary depending upon age, longevity, and income levels. Those who are older, live longer, and have lower incomes come out further ahead. Couples come out better than single wage earners because of the spousal benefit. For example, a single worker born in 1943 can expect a return similar to 2.49%, whereas a lower earning couple born in 1943 would have around a 6.79% return. For more information on this comparison, click here.
In the 1980s I sent my research paper titled “Why are Americans Poor Savers, What is the Solution?” to President Reagan. The bottom line of the paper showed that people in many countries have the attitude that they work hard for their money and have the right to keep it. In contrast, many Americans have the prevalent attitude that they work hard for their money and have the right to spend it. Part of my research paper pulled on the Cato Institute research that a solution to the future Social Security shortfall is to have employees keep and manage their portion of the Social Security tax and the employer portion goes to make current payments to beneficiaries.
Analysis shows that if someone invests 7.5% of all earnings and gets a reasonable return, the result is that over 90% of their income can be replaced in retirement from their own funds. This means they have to leave it alone, not spend it, and let it grow. If adverse life events happen such as a death or disability, they could access these funds if needed. These funds also add to the overall investment base in the country.
The $2.9 trillion in the Social Security trust is not an invested balance. It is an IOU stuffed in a drawer in the government’s financials. The Cato Institute continues to update and propose their research and possible solutions. They review case studies from other countries where this approach has worked because the funds have the potential to have a better return than 2% above inflation. These solutions have never been accepted in the U.S. and there are ongoing campaigns against privatization of Social Security.
From my perspective, there appears to be a lack of understanding. For example, AARP’s position includes battling against such an approach. That is why I personally will not become an AARP member despite some of their perks for retirees. It baffles me why organizations, politicians, and other leaders want people’s money controlled by the government instead of managing it themselves.
I received a response from President Reagan and he said that the government would never institute a forced savings program even though a nation like Singapore has found this model to be very successful. So instead, the U.S. will continue to impose a forced tax.
America has several ways to solve this problem since the population will not likely accept a decrease in benefits. In 2020, 61% of all U.S. taxpayers paid no federal income tax according to the Tax Center Policy.
Almost every worker pays the 7.65% FICA tax which includes the 6.2% for the OASDI benefit.
Solutions may include:
- further delaying the age for full retirement benefits.
- taxing more of Social Security benefits.
- having a means-tested approach where your benefit is reduced when you have other sources of income above a certain level.
- increasing the FICA tax. The global employer average tax rate is 15.34% versus 7.65% in the U.S. Europe’s average employer tax is 20% in 2021. For example, Spain and Italy’s rate is 30% and France’s rate is 45%. Many of those countries have had a Social Security-like program longer than the U.S. and have higher rates because they didn’t properly address the problem either.
The positive news is that Social Security in the U.S. is not expected to go away, but it is likely to keep changing. The later a solution is implemented, the higher the cost to workers and companies in the future. My philosophy is the more you save on your own, the less you will be dependent upon the government. If you have additional comments or questions, feel free to email me at DStrege@onlyworkforyou.com.
Social Security Articles/Resources
“How Much of Your Retirement Income Will Come from Social Security?” by Christy Bieber
“Social Security Reserves to Be Depleted Earlier than Previously Expected” by Kiplinger
“Will Social Security Go Bust?” by Vawter Financial
“Social Security: Continuing to ‘Kick the Can Down the Road" by Social Security Report
“The Combined Social Security Guarantee and Social Security Plus Initiative by Association of Mature American Citizens” by AMAC
“Dear Young People: You WANT Congress to Kick the Can Down the Road on Social Security” by Neil H. Buchanan
“Social Security at a Glance” by the Cato Institute
“Cato Institute’s 6.2 percent Solution on Social Security” (Video)
“Cato’s Handbook for the 107th Congress” by the Cato Institute