Image source: Pixabay.
Continue Reading Below
Social Security, the program designed to provide income to workers in retirement, as well as the disabled and survivors of deceased retirees, has a retirement problem.
While Democrats and Republicans might appear to disagree on everything, one common belief all policy-makers share, regardless of political affiliation, is that Social Security's current path is unsustainable. The retirement of baby boomers in increasing numbers over the next two decades is going to weigh on the worker-to-beneficiary ratio. In simple terms, there just won't be enough new workers generating payroll tax revenue to cover the amount of benefits being paid out.
The other issue here is that people are living longer than ever (oh darn, right?). Life expectancies have risen by nine years in the U.S. over the past five decades, and if people are living longer, they'll be able to draw Social Security benefit payments for a longer period of time.
Put these demographic shifts together and, according to the latest Social Security Trustees' report, the Old Age, Survivor and Disability Insurance Trust Fund will burn through its remaining cash reserves by 2035. This doesn't mean Social Security is bankrupt or insolvent, but it does mean that tax revenue needs to be raised, benefits needs to be cut, or some combination of the two needs to be enacted by Congress at some point in the next 19 years.
Image source: Flickr user Sebastiaan ter Burg.
Continue Reading Below
The American public weighs in on Social Security
What tools does Congress have at its disposal? A dozen possible solutions, and maybe more, have been proposed by lawmakers to fix an imminent funding shortfall. About half of the fixes entail some form of tax increase, while the remainder rely on benefit cuts. We've also witnessed a call from one of this year's presidential candidates for a partial privatization of the program.
Which solution is the best? If we knew that answer, the problem would presumably have been solved a long time ago. Every solution comes with pros and cons, and thus far lawmakers have been unable to come to a middle ground on how to sustain Social Security for decades to come.
Despite lawmakers scratching their heads, the American public has had an opportunity to weigh in. In 2014, The Washington Post conducted an informal poll that allowed readers to select any fixes they approved of (there were 12 in total). The solutions presented were split -- half tax increases and half benefit cuts. The answers, as you might imagine, were all over the place, with many responses garnering favorability ratings between 15% and 35%, with a few exceptions.
The most hated Social Security fix -- would it work?
Perhaps the biggest exception was the most hated Social Security fix of all based on the responses: doing nothing at all and passing the problem to the next generation of retirees. In other words, in 2035, when the cash reserves of the OASDI have been completely used up, allow a 21% benefits cut to occur across the board to sustain benefit payments for another 52 years, through 2087. Just 2% of all poll respondents selected this answer as a solution they'd be willing to stand behind.
We know by the results that almost no one likes the idea of Congress simply twiddling its thumbs on Social Security and passing the problem to the next generation -- but would doing nothing actually work?
Image source: Flickr user ITU Pictures.
Amazingly, there are some positives to this much-hated Social Security fix. For starters, doing nothing and cutting benefits by an estimated 21% would completely fill the gap caused by shifting demographics. Only a select few solutions completely bridge the monetary shortfall in Social Security, and this fix is one of them. If benefits are cut 21%, the program should remain solvent for another five-plus decades.
Another interesting point is that going this path would probably spark some urgency among Generation X and even millennials to diligently save money and invest wisely for their future. If their benefits from Social Security are expected to be cut, they'll likely turn to other means to fund their retirement. The Social Security Administration suggests that benefits paid should cover only 40% of a retiree's previous work income, so going the "do nothing" route may actually lessen some Americans' reliance on the program.
A third positive point is that the expectation of a cut might encourage Americans to work longer, assuming their health cooperates. Working longer would allow an eligible pre-retirees' benefits to grow at a rate of 8% per year between age 62 (the first point at which benefits can be claimed) and age 70. Plus, income generation from working could go toward monthly expenses, or be added to a retirement account. The Social Security program also benefits by receiving additional payroll tax revenue. Thus, if a person is capable of working longer than, say, age 62 or their full retirement age, they could net a higher benefit payment (even if there's a 21% cut) and may wind up with more in retirement savings.
Image source: Flickr user Craig Sunter.
But (surprise, surprise!) there are also major concerns associated with this hated Social Security fix. Tops among those is what might happen to lower-income retirees. Let's not forget that while Social Security provides a benefit to all eligible retirees, regardless of their socioeconomic status, it's really there to provide a financial foundation for lower-income retirees. If these individuals suddenly faced a 21% benefits cut, it could be devastating. In addition, while the urgency to save and invest might work for the middle class, it's a lot tougher for lower-earning households to put away ample cash and invest for the future. Thus, what happens to low-income Americans is a major concern of the do nothing strategy.
Also, it's possible that money saved by cutting benefits in the Social Security program could just wind up coming right out of the budget elsewhere. Income security, which includes food, housing, education, and other financial assistance programs for lower-income citizens, could find demand for funds increases dramatically once Social Security benefits are cut across the board. Income security accounted for $546.4 billion of the $3.8 trillion-plus federal budget in 2016, and it's possible this figure could rise substantially if a steep benefits cut is in order.
Finally, we can't discount the education gap inherent in Social Security and investing in general. Put plainly, a lot of people just don't have a firm understanding of Social Security or basic investing principles, so reducing what can be perceived as entitlement income during retirement is a serious concern. True, for some Americans the urgency to take hold of the financial future will improve; but a lack of financial know-how will hold others back.
Ultimately, I don't foresee the do nothing approach succeeding with lawmakers, mainly because of its rampant unpopularity among the public, and considering what it might do to low income Americans whom the program is designed to protect. Nonetheless, it'll remain one of about a dozen fixes on the table for lawmakers to pore over in an effort to solve Social Security's forthcoming funding shortfall.
How would you fix Social Security? Sound off in the comments below.
The article Could the Most Hated Social Security Fix Actually Work? originally appeared on Fool.com.
Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
Copyright 1995 - 2016 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.