This past August was the 88th anniversary of the Social Security Act, passed by Franklin D. Roosevelt as part of the New Deal domestic program in response to the Great Depression. More and more these days, we at EKS hear from people concerned about whether Social Security will disappear. Various surveys show Americans worry that Social Security benefits will not be available during retirement. The idea of retirement can be anxiety-producing enough without worrying about whether Social Security will be there. The current political discourse and news reporting do not help the situation.
What are the basics of Social Security benefits?
The Social Security Act was designed to pay retired workers aged 65 or older a continuing income after retirement. It was basically longevity insurance, as the starting age for collecting benefits at 65 was greater than the average life expectancy at the time. Currently, over 67 million Americans receive Social Security benefits.
Social Security is funded by payroll taxes paid by workers and employers under the Federal Insurance Contribution Act (FICA). Each worker and employer pays a tax of 6.2%, or 14.4% in total, up to a maximum income level of $160,200 into the Old Age and Survivors Insurance Trust Fund (OASI). If you are self-employed, you are responsible for the full 14.4%. The OASI Trust was established to provide for periods of fluctuation in the workforce, thus receiving more inflows when there is a larger workforce than the retiree pool, and vice versa.
So why all the worry?
Social Security is a pay-as-you-go system funded with taxes paid by current workers. 2023 is the first year the taxes generated by the American workforce are less than the payments to retirees. Since the current workforce is less than the number of retirees receiving the benefit, the government has to use funds in the OASI to fund the shortfall. This trend will deplete the OASI Trust by 2033 (per the latest Social Security Trustees report). This is why you hear terms like “Social Security insolvency” and “Social Security becoming bankrupt.”
Should you worry about Social Security benefits?
There is a common misconception or misunderstanding of the terms used to describe the status of the Social Security system and OASI trust fund. What does it mean that Social Security will be insolvent or bankrupt? When most people hear these words, they think there will be no money to pay the expected benefits. They believe Social Security will end or disappear, and their benefits will be $0 starting in 2034. That is not the case. Remember, current employees and employers will still be taxed 14.2%, thus adding to the system. The OASI trust was made for fluctuations in workforce like we are seeing now due to the baby boomer’s retirement influx. Suppose no changes are made to the system (the last major change was in 1983). In that case, it is estimated that retiree benefits will decrease approximately 20-25% in 2034, but recipients will still receive up to 75-80% of their benefits.
Several proposals are being discussed on how to “fix” Social Security. They include:
- Increasing the retirement age to 70
- Increasing the payroll tax above 14.2%
- Raising the cap on the number of wages taxed above $160,200
Each of these proposals would help alleviate the drag on the Social Security Trust fund and allow retirees to receive their full benefits after 2033. Both aisles of government know the issue, but politics is getting in the way of compromise to ensure retirees receive their full retirement benefits for life. There is no urgency for the politicians to act, as there are still ten years remaining before insolvency. But we believe something will be done to address this shortfall in due time.