A frequent topic in news stories is the American Social Security system, and the headlines continue to spread fear of Social Security running out of money. So, is this true, or is it simply a headline designed to grab your attention and make you tune in? Millions of retirees depend on Social Security benefits as their primary source of income. If the system runs out of money, many retirees will be in dire financial situations.
Thankfully, the circumstances are not as dire as the headlines might lead you to believe. However, some changes will be needed to funding or benefit payments in the coming years. Keep reading to get all the details on the future of Social Security.
Will Social Security Run Out?
The short answer is no. Social Security will not run out of money and go bankrupt. However, to fully understand the issues facing Social Security, you must first understand how Social Security works. As most people know, workers must pay a 6.2% payroll tax to fund Social Security. Employers also pay this same amount, so self-employed individuals pay the full 12.4% tax. The proceeds from these taxes are placed into the Social Security Trust Funds which are used to fund the benefits paid from the system.
Surplus of Funds
For many years, the Social Security system had a surplus of revenue. This means that more revenue was collected through taxes than was owed in benefits to Social Security recipients. This surplus remained in the trust funds and was invested in treasury bonds. This allowed the trust funds to earn interest on this money and grow the amounts in these funds even larger.
However, in recent years, Social Security’s liabilities have exceeded its revenue. Thankfully, the interest earned in the trust funds has been enough to cover this difference. But that started changing in 2021. The interest is no longer enough to cover the difference, and the Social Security Administration is beginning to draw down the balance in the trust fund to cover all its liabilities.
Baby Boomers
With the large number of baby boomers reaching retirement age and Americans living longer, the taxes collected from current workers are not enough to continue funding the system as it has in the past. With its current obligations, Social Security has enough money to continue payments until about 2035.
At that point, it would only have enough revenue to pay about 79% of its promised benefits. While Social Security will technically not run entirely out of money, it cannot continue to operate in its current format much longer. So, Congress must look for alternative funding methods or changes to benefit payments.
KEY TAKEAWAYS
- It is doubtful that the Social Security system will become insolvent; however, under the current structure, it can only fund a portion of the future retiree benefits.
- Several essential items are impacting the future of social security: a) lower birth rates, b) cost of living increases, and c) higher life expectancy.
- Congress must act quickly to modify the Social Security program by increasing FICA taxes, reducing benefits, or combining solutions.
How The Social Security Trust Fund Works
We have briefly touched on how Social Security works, but now we will look deeper into how the trust funds work. Social Security trust funds work the same way traditional personal trust funds do. Money is deposited into the fund, which a trustee manages. The money in the fund is invested so that it draws interest. Ideally, you can live off the interest and never touch the base amount of the fund.
In the case of Social Security, the fund is managed by a Board of Trustees instead of a single trustee. Each year, the Board must release an annual report showing the fund’s solvency.
Trust Income & Expenses
It helps to consider the overall cash flow of the Social Security system. Income consists of the interest from the trust fund and Social Security taxes collected from today’s earners or workers. Expenses, or liabilities, of the Social Security program trust fund, include retirement benefits, disability insurance benefits, and survivors insurance benefits.
Expense Coverage
Prior to 2021, the trustee’s report showed that Social Security could pay its expenses with its current payroll taxes and the interest from the trust fund without touching the fund’s base amount. However, starting in 2021, the interest from the fund is no longer enough to account for the shortfall between tax revenue and benefit payments.
Congress is now drawing down the base amount in the trust fund, and the interest earned on the fund will become lower and lower. This results in a more significant shortfall each year and the trust fund will be depleted even quicker. This is why the Federal government is examining ways to restructure the Social Security system to keep it going in the future.
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What Does The Future Of Social Security Look Like?
No one is certain what the future of Social Security looks like, although there are a few certain things. With its current revenue and obligations, Social Security has enough money to continue running until approximately 2035. Past that, the program would only have enough money for around 79% of its obligations. This is due to a few factors, but mainly because more people are receiving retirement benefits than workers to fund them.
Impacts On Social Security
- Birth rates have declined recently, meaning fewer people will be in the workforce.
- In addition, the Coronavirus pandemic caused the loss of millions of jobs, leading to substantially lower than-normal tax revenue.
- Cost-of-living adjustments have also increased Social Security’s benefits payments, creating a more significant deficit.
- Lastly, life expectancy in the United States continues to increase, so Social Security must pay benefits to retirees for longer.
Given the information above, it is evident that some changes will be required. We will discuss what those changes might look like later in this article. Just know that it is vital to plan for retirement and stay informed on your Social Security payments when you reach full retirement age. Being educated and informed about the situation is a great first step to staying financially stable in your retirement.
TIP
Social Security was not designed to be the sole source of income for retirees. Planning for retirement early and having additional retirement funds outside Social Security is essential.
Getting An Early Head Start On Securing Your Retirement
With Social Security cuts likely soon, how can you best retirement plan to ensure you have enough money to live? You should start early and save as much as possible on your own. Many Americans do not even believe they will receive any money from Social Security when they retire, so you should be able to survive from your savings and investments when you reach retirement age.
401k Contributions
If your company offers a match on your 401(k) savings, you should contribute the maximum amount your employer will match. This amount should be your minimum contribution! The money you place into your 401(k) is not taxable, so it will also help save you some money on your tax bill with the IRS in your younger years.
Traditional and Roth IRA Contributions
In addition, you should consider both traditional and Roth IRAs. There are differences between Traditional and Roth IRAs, so you should consult a tax professional to decide what is best for your situation.
The most significant difference is that traditional IRAs are funded with pre-tax dollars, and Roth IRAs are funded with after-tax dollars. This means you will pay income tax on a Traditional IRA when you withdraw the money but will not pay additional taxes on the Roth earnings at withdrawal. There are also contribution limits based on your current income, so you might be unable to contribute as much as you would like to your Roth account.
Start Saving Early
The main point is that whatever savings or investment strategy you decide is up to you; however, you should have a plan and work toward your goal. Start saving as early as possible – even when you get your first job. The sooner you start saving for your retirement plan, the easier it will be to hit your goal and survive without relying on Social Security. Retirement planning might sound complicated, but it doesn’t need to be highly complex. Again, you can always consult with a financial planner to help you make sure you will have enough retirement income when that time approaches.
Possible Solutions For Social Security
Many ideas have been suggested for fixing Social Security. Lawmakers have been slow to act because many feel that whatever solution they choose will not sit well with voters. In addition to retirement benefits, many think they should act on changes to Medicare to revamp the way that retiree healthcare is handled. That is a separate topic since this article focuses on Social Security retirement benefits.
Increase FICA Taxes
One of the most apparent suggestions for fixing Social Security is to increase the FICA payroll tax rate. This would create more income for the program to use to pay benefits, but most people do not enjoy tax increases.
Modify Benefits
Another possible solution is to increase the full retirement age for eligibility or implement benefit cuts that decrease the amount of total benefits. Both solutions would reduce Social Security’s liabilities, but most people do not enjoy these possibilities.
Cutting Social Security is not a popular topic. Even though Social Security solvency should not be an issue for many years, Washington D.C. must act quickly to avoid a sudden benefits drop in about ten years.
The Bottom Line
Social Security should never go entirely bankrupt as long as people continue working and paying taxes, but the program will need some changes.
While it might require more taxes or lower benefits, Congress must address the situation sooner than later. The best thing you can do to plan for these changes is to increase your savings and not rely on Social Security for your retirement income.
Frequently Asked Questions
If no other changes are made, Social Security will not have enough money to pay all benefits in 2035. While it will still be solvent, it will only have enough money to pay about 79% of its obligations, so recipients might see their monthly income cut.
At this point, the base amount in the trust funds will have been depleted due to the revenue and payment deficit over the last several years.
In a worst case scenario, Social Security would no longer be able to provide benefits to recipients. However, Social Security running out of money completely is not likely. The more likely scenario would be that recipients see their benefit amounts reduced because Social Security no longer has enough revenue to fully fund its benefit payments.
Social Security is the largest item in the Federal budget. The government spent approximately $1 trillion on It in 2019, and that number typically increases every year. It accounts for roughly one-quarter of the budget for the entire Federal government.
Social Security is not a Ponzi scheme. In a Ponzi scheme, new investors must pay returns to current investors. Each time a payment is made, the number of new investors must double because there are twice as many existing investors to pay.
Social Security is a pay-as-you-go system. Today’s workers are paying benefits for today’s retirees, and the next generation will pay benefits for the next generation. The system will continue to operate as long as people continue to work. Some also wonder whether Social Security is socialism, but that is a separate discussion.
You can find a Social Security Administration office near you by using our SSA office locator and searching for your closest location.
