Contributed by: Robert Ingram
For the past several years, you may have seen story after story questioning the health of the Social Security system and whether the federal program can be sustained into the future. If you, like many clients, are thinking about your retirement plan, you’ve probably wondered, “Will my Social Security benefits be there when I retire?”.
Certainly, different actuarial or economic assumptions can influence Social Security’s perceived financial strength and solvency, but it’s clear some steps must be taken. With a system the size and scope of Social Security, one that affects so many people, it's hard to overstate the challenge of finding solutions on which lawmakers and experts can agree.
Funding Social Security - Money In, Money Out
Payroll (FICA) taxes collected by the federal government fund Social Security. How much do we pay? The first $132,900 of an individual’s 2019 annual wages is subject to a 12.4% payroll tax, with employers paying 6.2% and employees paying 6.2% (self-employed individuals pay the full 12.4%).
The government deposits these collected taxes into the Social Security Trust Funds, which are used to pay benefits. Social Security benefits are also at least partially taxable for individuals with income above certain thresholds. For more on Social Security taxation, click here.
U.S. demographic changes pose challenges for Social Security’s financial framework. Americans are living longer, but birth rates have declined. One implication is that while a growing population draws Social Security benefits, a smaller potential workforce pays into the system.
In its 2018 annual report, the Social Security Board of Trustees projected that the total benefit costs (outflows) would exceed the total income into the trust funds, and the trust fund reserves will be depleted by 2034. Now, the report does not suggest that Social Security would be unable to pay benefits at that point. It estimates that with the trust funds depleted, the incoming revenues would be able to cover about 77% of the scheduled retirement and survivor benefits.
This is still concerning for the millions of retirees collecting their benefits and for future retirees counting on their benefits over the next 15 to 20 years.
So the question is, how can we correct this funding shortfall?
Possible fixes for Social Security?
Ultimately, as with any budget, fixing the imbalances between the Social Security system’s inflows and outflows would involve increasing system revenues, reducing or slowing the benefit payouts, or some combination of both.
There have been a number of proposals discussed in recent years, including:
Increasing the Full Retirement Age from age 67
Changing the formula for calculating benefits based on earnings history
Increasing (or even eliminating) the cap on income subject to the payroll tax
Reducing benefits for individuals at certain income levels (“means testing”)
Changing how the cost of living adjustment (COLA) for benefits is determined
This past January, the Social Security 2100 Act was re-introduced in the House of Representatives. This series of suggested reforms, originally introduced in 2014 and 2017, has several key items:
Increase the Primary Insurance Amount (PIA) formula for calculating benefits at one’s Full Retirement Age
Change the Cost of Living Adjustment (COLA) calculation, tying it to the Consumer Price Index for the Elderly (CPI-E) rather than the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W)
Increase the special minimum Primary Insurance Amount for workers who become newly eligible for benefits in 2020 or later
Replace the current thresholds for taxing Social Security benefits, from a threshold for taxing 50% of Social Security benefits and a threshold for taxing 85% of benefits, to a single set of thresholds set at $50,000 (single filers) and $100,000 (married filing jointly) for taxation of 85% of Social Security benefits, by 2020
Apply the payroll tax rate for Social Security (12.4% in 2019) to earnings above $400,000
Continue applying the the payroll tax to the first $132,900 of wages and exempting income from $132,901 up to $400,000, then apply the tax again to amounts above the $400,000 threshold
Increase the Social Security payroll tax rate incrementally from the current 12.4% to 14.8% by 2043
The rate would increase by 0.1%age point per year, from 2020 until 2043
Combine the reserves of the Social Security retirement and survivor benefits trust fund and the reserves of Social Security’s disability benefits trust fund into a single trust fund
(Note source data: Estimates of the Financial Effects on Social Security of the “Social Security 2100 Act” ssa.gov/OACT/solvency/LarsnBlumenthalVanHollen_20190130.pdf)
Interestingly, the first four provisions in the proposed bill are actually intended to increase the benefits for recipients. The first provision would slightly increase the benefit amounts paid to recipients through the new formula. The change to CPI-W gives more weight to spending items particularly relevant for seniors, such as health care, resulting in a potentially higher COLA than under the current structure. The third provision increases the current minimum benefit earned, and the fourth item allows for a higher level of income before Social Security benefits become taxable.
To address Social Security’s long-term solvency, this bill focuses on boosting Social Security revenues by increasing the payroll tax rate over time and making more earned income subject to those payroll taxes. That approach is in contrast with other proposals that would focus on managing the outflow of benefits, such as raising the full retirement age from 67 to 70.
This illustrates the philosophical differences in how to address the problems facing Social Security, and what makes reaching consensus on a long-term solution so difficult.
Should I plan for changes to the Social Security system?
With so many factors at play and strong voices on different sides of the issue, the specific reforms Congress will adopt and exactly when they will occur remain unclear. For most clients, Social Security is part of their overall retirement income picture, but a meaningful source of income.
It is important to have at least a basic understanding of your benefits and what affects them under the current system (benefits collected at full retirement age, changes to benefit amounts based on when they are collected, and the potential impacts of taxation on your benefits, just to name a few factors).
Understanding how your Social Security benefits fit within your own retirement income plan can help you stay proactive as you make decisions in the face of uncertainty, whether controlling your savings rate, choosing investment strategies, or evaluating your retirement goals. If you have questions about your retirement income, we’re always here to help!
Robert Ingram, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® With more than 15 years of industry experience, he is a trusted source for local media outlets and frequent contributor to The Center’s “Money Centered” blog.
*Repurposed from 2016 blog: Will Social Security Be Around When I Retire?
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