As a financial planner, I frequently get asked if Social Security is running out of money. According to their own projections, the Social Security trust fund reserves is expected to be depleted by 2035. Whether you’re currently retired, nearing retirement or planning for a retirement in the distant future, that’s a scary headline to read. Social Security is no small part of our economy either, with 67 million beneficiaries receiving benefits and $1.38 billion benefit payments per year (and growing), the health of Social Security is on the minds of many Americans these days.
What the headlines won’t tell you
If the trust fund reserves run out in 2035, the current assumptions show that the income from payroll taxes would be sufficient to cover 83% of promised benefits until the year 2098 and 73% of the promised benefits thereafter. So, let’s say your monthly benefit is $2,000 per month and it’s 2036 and the trust fund is depleted your benefit would go down to $1,660 per month. Obviously, this is not the ideal scenario but it’s also not as if you’d be receiving nothing.
We’ve been here before
This is not the first time that Social Security has faced this type of funding issue. In the early 1980s, the trust fund was within months of becoming depleted when the congress stepped in and made many material changes to the system that extended the life of Social Security for decades.
Some of the solutions they used to extend Social Security are avenues that could be used again. Let’s examine three of those methods to hopefully give some relief and hope that there are levers the government can pull to maintain a healthy system for the millions of workers that have spent a lifetime paying into the system.
Three ways to extend Social Security
Payroll Taxes
The main way that Social Security is funded is through payroll taxes, also known as FICA taxes. Currently the FICA tax rates are 6.2% for Social Security and 1.45% for Medicare. Both the employee pays this as well as the employer. Self-employed individuals pay both the employer and employee portion of these taxes.
The most logical place to start to extend the trust fund reserves would be to increase the percentage going to Social Security. This would bring in more revenue to the trust fund to offset some of the benefits being paid out.
But wait, there’s a twist! The 6.2% of income tax only goes up to $168,600 of income for those working, so once past this income threshold, you don’t pay any additional into Social Security.
This income threshold has been rising; a decade ago in 2014, the income threshold was $117,000 (anything earned over this was not taxed for Social Security). This income threshold will most likely need to be increased at a faster rate to extend the reserves into the future.
Retirement Ages
One of the changes the Reagan administration signed into law in 1983 to help extend the trust fund was to gradually raise the full retirement age (the age you get your full benefit) of social security from 65 to 67, depending on your year of birth. The first group of retirees this affected were 40 years old at the time. The thought was they would have time to plan for this change and that they would live longer than current retirees at that time.
According to the CDC, in 1983 the life expectancy of Americans turning 65 was 81.7. In 2022, the life expectancy of someone turning 65 in America was 83.9. In general, people are living longer thanks to advances in medicine. While a 2.2-year difference in life expectancy may not seem huge, that’s (on average) 2.2 more years of benefits Social Security is paying out of the trust fund. Apply that to 67 million people and that payout adds up quickly. Pushing full retirement age back again for those who are younger and still have time to plan and will more than likely live longer than those on Social Security currently could be one avenue that congress might explore.
Taxation of Benefits
The benefits someone receives may be taxable depending on their income levels. Some lower income people’s benefits are completely tax free while higher income individuals will have up to 85% of their benefits taxable. One important distinction is this 85% is taxable (the amount included in your taxable income), NOT taxed at 85%. Also, an important distinction many may not know about is that the taxes paid on Social Security benefits go directly back into the Social Security trust fund not in the general account that regular income taxes go into.
A few different options the government would have here is to make the higher income individuals benefits 100% included in their taxable income. If they needed to go a step further, they could just make all benefits paid included in taxable income for everyone receiving benefits.
These are just three different options the government used in the 1980s to extend the Social Security trust fund reserves that could be altered and used again. While these options would no doubt be painful for either those working, planning to draw on Social Security later in life, or currently receiving benefits, clearly some tweaks need to be made to keep the system on solid footing. Like investing often is, the short-term pain would be worth the long-term rewards. There are probably a dozen other options of how to extend the reserves that I didn’t discuss and realistically the solution won’t be just one quick fix it will be a handful of minor changes that will collectively have long-term success.
“Control What You Can Control”
I had a basketball coach who always said, “control what you can control.” While we can’t control what congress ultimately decides to do to fund Social Security, what we can control is having a plan for our retirement. For those on Social Security or within five years of being eligible you are probably safe to count on Social Security for retirement income but it’s still a good conversation to have. To those currently 40-55, I think assuming Social Security will be around to some capacity is safe, but I would test your plan to see what it looks like with reduced Social Security (maybe 83% like the estimates) or even without Social Security. To those under 40, I would suggest making a retirement plan/goal without Social Security included to see if you are setting yourself up to not be reliant on it if it is either not there or greatly reduced.
The current estimates say the reserves will run out in 2035, that’s almost a decade away. In 1983, the reserves were within MONTHS of being depleted. As history doesn’t always repeat itself but it tends to rhyme, I wouldn’t expect to see a solution to this issue until late 2034. That means this is an issue you will likely hear about for some time to come.
Just remember, even if the reserves run out, payroll taxes will be enough to pay 83% of benefits until 2098 and there are many levers the government can pull to extend the trust fund’s excess reserves. Social security planning can be tricky. Give us a call to put together a plan of how and when the best time is to start your Social Security benefits.
