President Obama Believes This Is the Best Social Security Fix -- Is He Right?

By Markets Fool.com


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There are no two ways about it: Social Security is a program that's critical to the financial well-being of seniors. Unfortunately, based on current law, Social Security won't be able to sustain its current level of benefits forever. The right fix is crucial, but there's a lot of controversy about which fix is the best for Social Security.

Social Security's unsustainable path

According to the latest Gallup survey, 59% of currently retired seniors count on Social Security to generate the majority of their income. Add in the seniors who responded that Social Security is a minor source of monthly income, and 90% of all seniors surveyed by Gallup rely at least somewhat on income from Social Security to make end meets during retirement. That's a high figure, and it's not expected to ebb anytime soon, with a majority of baby boomers and pre-retirees projected to lean heavily on Social Security in retirement.

If the Social Security system were on solid footing, that'd be one thing, but unfortunately it's not. The 2015 report from the Social Security and Medicare Board of Trustees forecasts that the Old-Age, Survivors and Disability Insurance (OASDI) Trust will burn though its excess cash reserves, which stood at $2.83 trillion at the end of April 2016, by 2034.

The reason the OASDI's cash reserves are expected to run out can be traced to three primary sources. First, people are living longer than ever, and longer lives mean a lengthier payment period for the Trust. Secondly, boomers are retiring at a rate of around 10,000 per day, and essentially will be doing so through 2030. The more baby boomers retire, the more the worker-to-beneficiary ratio will be pressured. Finally, Social Security's investment holdings simply aren't earning much in the way of interest thanks to accommodative monetary policy from the Federal Reserve, which has kept interest rates low on interest-bearing assets. Or, to summarize all three points succinctly, the program simply won't be bringing in enough money to maintain current benefits based on the number of projected beneficiaries in 2034.

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Now here's the good news: burning through the programs' excess cash reserves does not mean the program is insolvent or bankrupt. Therefore, no matter what your age now, Social Security will be there to pay you some form of benefits when you retire (assuming you have enough work credits earned to qualify for benefits).

The bad news is that the benefit payment you receive could be substantially less than what you expect. The Board of Trustees has suggested that a benefit cut of up to 21% could be needed to sustain the program for another 55 years, or through 2089. If you're among the majority of seniors counting on Social Security to provide a financial foundation, a 21% haircut to your income is not what you want to hear.

It's also not want President Barack Obama wants to hear.

President Obama has a solution to fix and expand Social Security

While speaking in Elkhart, Ind., two weeks prior, Obama called for expansion of the Social Security program to protect current and future retirees. In the words of the President,

"It's time we finally made Social Security more generous and increased its benefits so that today's retirees and future generations get the dignified retirement that they've earned."


Image source: White House on Flickr.

What did President Obama propose as the solution to fix Social Security's current woes and make this vision a reality? None other than the most popular solution (by far) as voted by readers in a 2014 poll from The Washington Post -- raising the payroll tax cap on earnings.

As it stands in 2016, income up to $118,500 is subject to the Social Security payroll tax of 12.4%. Normally you and your employer split this tax down the middle, 6.2% each, but self-employed persons face the full brunt of this 12.4% tax. For the average household earning around $51,000 annually, every single dollar earned is subject to the payroll tax. However, for a multi-millionaire, only the first $118,500 of income is subject to the payroll tax. The payroll tax earnings cap moves higher by the nominal rate of inflation each year.

The allure of raising the payroll tax cap is that only around 10% of the population is earning in excess of $118,500 annually, meaning it would only affect a small percentage of the population -- a population that President Obama believes can afford to pay more. It's unclear what shape a payroll tax earnings cap increase might look like. Some legislators have suggested removing the cap completely and exposing all income to the payroll tax, while others have offered a conciliatory increase where an exclusionary gap would exist between the current year earnings cap and some arbitrary higher figure, say $250,000. Thus, earned income between $1 and $118,500, as well as $250,000+, would be liable for the payroll tax.

Would Obama's Social Security solution fix and expand the program?

Of course the big question is "would it work?" Based on research conducted by the Center for Retirement Research (CRR), the answer would be a resounding "No."

According to the CRR, many of the most popular solutions to fix Social Security simply don't cover the full breadth of the income shortfall. Raising the payroll tax earnings cap would take care of about 30% of the financial shortfall of the program, and very likely could extend the date by which its excess cash reserves are exhausted. However, simply taxing high-income individuals doesn't assuage Social Security's long-term problems.

Other popular solutions, such as raising the retirement age, changing how cost-of-living adjustments are calculated, or privatizing Social Security and allowing for investment in higher return assets such as the stock market, all fail to close the expected cash shortfall caused by longer life expectancies and baby boomers retiring. In fact, based on CRR's data, you could combine all four of these most popular options and you still wouldn't completely close the projected budget shortfall.


Image source: Pixabay.

Another thing to keep in mind is that Obama didn't suggest maintaining benefits, but expanding them for current retirees and future generations of retirees. The above figures take into account simply maintaining the status quo. Expanding benefits is an entirely different beast, and implementing any combination of the aforementioned solutions would likely put legislators miles away from an actual fix.

My best guess is that a solution to fix Social Security is probably going to include a payroll tax hike across the board, regardless of income, as well as potential means-testing that reduces benefits on well-to-do persons. The 2015 Board of Trustees report estimated that a 2.68% tax increase, or presumably a 1.34% increase for employer and employee, would take care of the upcoming deficit woes. The Trustees suggest that the longer Congress waits to enact these tax increases, the higher the increases would need to be to cover the projected cash shortfall.

Regardless of the type of solution, we can say with some degree of certainty, utilizing CRR's data, that simply having wealthier individuals pay more isn't going to cover the projected deficit. This probably means more discussions to come on how to best fix Social Security, and all the more reason for you to ensure that you have alternate sources of income available (401(k), IRAs, or pension) when you retire.

The article President Obama Believes This Is the Best Social Security Fix -- Is He Right? 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, 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.