Millions of Americans receive Social Security benefits each month. These benefits are in the form of retirement benefits as well as Social Security disability benefits. So, where does the money come from to pay these benefits and how is it managed? This is where the Social Security trust funds come into play. The trust funds play an extremely crucial role in the management and payment of these benefits, and they must be managed properly to maximize the funds held within them. Keep reading to learn about how these trust funds work as well as what the future of the trust funds might look like.
What Are The Social Security Trust Funds?
The trust funds are an integral piece of the puzzle when explaining how Social Security works in general. There are actually two separate trust funds that are used when it comes to Social Security. The first is the Old Age and Survivors Insurance fund, or the OASI trust fund. The other is the Disability Insurance trust fund. The first pays for both retirement and survivor benefits while the DI trust fund pays for disability benefits. When Social Security was first established back in 1935 by President Franklin D. Roosevelt, the law started the requirement for the collection of FICA taxes or OASDI taxes. These taxes which are still in existence today are payroll taxes that are collected to fund the benefit payments that Social Security must make. In 1937, the trust funds were established as a way to manage these dollars.
The trust funds are managed by a board of trustees who are part of the U.S. Treasury. Each year, this board must present an annual report to Congress showing the current status of the trust funds. Just like with other trust funds, the money in the Social Security trust funds is invested so that it earns interest and returns from the investments.
Social Security Funding Basics
Many people wonder, “How is Social Security funded?” Social Security is considered a “pay as you go” system. This means that the taxes collected from today’s workers are being used to pay benefits to current beneficiaries. The taxes that are collected are deposited into the trust funds, and the benefits are paid from the same funds. The current Social Security tax rate is 6.2% for both the employee and employer. This equates to a total tax of 12.4% of your salary. In addition, the Medicare tax is collected and placed into the funds at an additional rate of 1.45% for both employee and employer.
As previously stated, the Social Security payroll taxes collected are placed into the trust fund where they are invested and earn additional income for Social Security. Any money that is left over after all the benefits are paid is placed into the trust fund reserves. Since the inception of Social Security, there has been a surplus of funding almost every year. However, the Social Security program is now starting to have a shortfall each year. There are not enough workers paying into the system to pay all the benefits to current retirees. This is partly because of current demographics in which the baby boomers have reached retirement age and there is a shortage of younger workers. In addition, interest rates are extremely low, so the interest income generated from the trust funds is lower than usual.
Due to the factors above, as well as last year’s pandemic, the Federal Government had to dip into the trust fund reserves to meet the current commitments for benefit payments. The Social Security Administration cannot continue to operate forever by dipping into the reserves each year to pay its expenditures and program costs. Something must be done, and we will discuss potential changes later in this article.
Social Security Trust Fund Investments
Details of the investments in the trust funds can be found in the Social Security trustees report. However, you should know that the portfolio is not very diverse. In fact, the Social Security trust funds only invest in U.S. Treasury securities. These securities are similar to Treasury bonds and notes that are purchased by private investors. The securities are totally backed by the U.S. Government. Since the United States government has never defaulted on an obligation, these investments are highly considered to be one of the safest investments available anywhere.
Given the dollar amounts that Social Security works with each month, the investments earn quite a bit of interest. Social Security currently has almost $3 trillion invested in these securities. At an average interest rate of 2.5%, this means that the trust funds will earn about $70 billion in interest this year. Not only can most of this information be found in the annual report, but the Social Security Administration (SSA) issues monthly reports with details of these investments. You can even see the details of how many special-issue securities are held versus the public issue government securities. Special-issue securities are investments that are only available to the trust funds, while public issues can be purchased by private investors as well.
How Long Will The Social Security Trust Funds Last?
So, when will Social Security run out? Many people wonder about the solvency of Social Security and how long the trust funds will remain solvent. That question is often a topic of debate when it comes to politicians around election time. You can use the annual report and take a look at the actuary details to get a rough idea of how long it will be before depletion of the Social Security general fund. Most estimates show that Social Security has enough funding to pay its current obligations until the year 2033 for retirement benefits. This puts the fund running out of money one year sooner than expected, and the reports attribute this to the COVID pandemic.
After 2033, SSA would likely no longer be able to pay full benefits unless changes are made before then. It is estimated that Social Security would only have enough money to pay about 76% of its obligations after that date. Policymakers in the Senate and House of Representatives must act quickly to determine the appropriate fix for Social Security. Otherwise, many older Americans might find themselves unable to make ends meet each month or unable to receive critical health care services. There are several ideas on the table, although there are pros and cons to each. Here are some of the most common ideas that are currently being floated around.
Potential Fixes For Social Security
While no one knows for certain what the ultimate fix will be for Social Security, there are several options on the table. Some are more popular than others, although there does not appear to be a perfect, single solution. Here are some of the options.
— Raise The Retirement Age
One potential fix is to raise the full retirement age so that people must wait longer to receive full benefits. This option would mean that Social Security would end up paying less over the lifetime of a recipient since they must wait longer to start their benefits. This option is not extremely popular because the retirement age was raised from 65 to 67 not long ago. Raising the age even further could mean that many retirees might never see Social Security payments before their death. Most people do not want to continue working into their 70’s, so they would like to be able to receive full retirement benefits before then.
— Decrease Benefit Payments
Again, this is definitely not a popular option, but it is a possibility. Since Social Security has a shortfall in the collection of income taxes, they might simply be forced to reduce benefit payments. Since many retirees already struggle to make ends meet on Social Security benefits alone, this solution could put many people into a dire financial situation. Reducing benefit payments would cause the trust fund asset reserves to last longer, but it would cause a lot of grief among retirees. With inflation and prices of almost everything on the rise, a decrease in payments would not be good. Most recipients need their COLA increases each year to survive, so a decrease in payments could be detrimental.
— Increase Social Security Tax
Nobody likes tax increases, but an increase in the Social Security tax rate would lead to higher tax revenues. If Social Security collects more money each calendar year, then they would have more money to fund obligations. An increase of just a percent or two could have a huge impact on Social Security’s bottom line. This solution would likely keep Social Security operating like normal for many years into the future. However, getting politicians to agree on the timing and amount of the increase might be difficult. Social Security taxes in 2021 are already at a total of 12.4% plus an additional 2.9% on Medicare taxes.
— Increase Tax Limits
Instead of increasing the tax rate, Congress could decide to simply increase the tax limits. In 2021, individuals only pay Social Security taxes on their first $142,800 in income. There are many people who have income much higher than this, and that income is producing no tax revenue for the Social Security system. By increasing this limit, the tax revenues would again increase and help Social Security fund additional obligations. However, increasing taxes, regardless of the form, is never a popular topic. It is yet to be seen whether this solution will come to fruition or not.
The Bottom Line
Though many people might not know exactly how they work, the Social Security trust funds are critical to the operation of the entire program. These funds are where all the payroll taxes are deposited, and the funds are also used for all benefit payments. Though the funds have had a surplus that could be placed into reserves for many years, a shortfall is now being experienced. Without some action by Congress, Social Security will not be able to continue to operate like normal past the year 2033. No one knows what the future holds, but you can be certain that the trust funds are likely to continue to be an integral part of the operation of the Social Security system.
Frequently Asked Questions
Who owns the Social Security Trust Fund?
The U.S. government owns the trust funds, and they are managed by the U.S. Treasury. A board consisting of 6 members essentially runs and makes the decisions for the trust funds. A report is issued by the SSA each month that details the investment types, interest rates, and maturity dates of the securities in the funds.
When does Social Security start paying out more than it is taking in?
This has already happened. The first shortfall occurred in the 1970’s, but only for a year or so. Today, projections show a shortfall in every year into the future unless changes are made. Its current obligations are higher than the payroll taxes that it will collect. According to actuary reports, the shortfall is in the trillions and is almost 3% of the country’s GDP.
Is Social Security a Ponzi scheme?
No, Social Security is not a Ponzi scheme. Although taxes collected from current workers are used to pay benefits for current retirees, there is no promise of a return. In fact, people often pay much more into the system than they receive. While there may be some similarities in the fact that new workers must pay into the system so that current beneficiaries can receive payments, Social Security does not operate as a Ponzi scheme.
What is the maximum monthly payout for Social Security?
The most that someone who files for Social Security at full retirement age can receive is just over $3,100. If a person waits until age 70 to start their benefits, they can receive a maximum of almost $3,900 per month. However, the average Social Security retirement benefit is just less than $1,500 monthly. You can quickly see why people need to save for retirement on their own and not rely solely on Social Security. It would be nearly impossible to survive on Social Security payments alone.