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Social Security provides the backbone of financial support for retired Americans. Many are concerned about the financial challenges that Social Security faces, especially with the demographic shift that has millions of baby boomers retiring every year and starting to receive Social Security benefits. The Social Security Trust Fund currently has $2.8 trillion in assets that it intends to use to cover anticipated shortfalls in tax revenue over the next 20 years. But some portray the Trust Fund as a sham because it doesn't have any cash assets in its coffers, instead holding only special government obligations. Let's take a closer look at what Social Security has available in terms of finances and when it will get back the cash it needs to pay benefits.
How the Social Security Trust Fund can invest
Social Security is funded largely from the collection of payroll taxes from employees and employers. In the past, that revenue, combined with smaller sources of funding such as income tax revenue from the taxation of Social Security benefits, has been enough to pay out all benefits due and have money left over. That excess revenue was put into the Social Security Trust Fund, with the intent of setting it aside for later use.
However, the Social Security Trust Fund doesn't just hold onto that cash. Instead, it invests it, buying special government securities issued by the U.S. Treasury. The money is therefore transferred from one agency of the government to another, and the U.S. Treasury uses the cash to finance other operations of the government.
These special-issue securities come in two types. Certificates of indebtedness are available on a daily basis, and they mature on the following June 30. For longer-term investment, bonds are also available once per year on June 30. The trust fund can choose maturities of between one and 15 years.
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Current trust fund assets and rates of return
The trust fund has $2.825 trillion invested in these securities, according to the latest available data from the Social Security Administration as of April. About $77 billion is invested in certificates of indebtedness and the remainder in bonds.
The overall average rate of return that the Social Security Trust Fund earns is about 3.2%. Certificates of indebtedness currently pay between 1.75% and 2.25%, and the bonds that the trust fund holds have interest rates ranging from 1.375% up to 5.625%.
Current assets as of April 2016. Image and data source: SSA.
How the trust fund gets its cash back
One special feature of the investments that the Social Security Trust Fund holds is that the trust fund can redeem securities without penalty. The payroll tax revenue that the SSA receives is seasonal in nature, because self-employed individuals pay their payroll taxes in estimated tax payments every quarter and tend to make large lump-sum tax payments with their annual tax returns. The combination of lumpy revenue and regular monthly benefit payments made throughout each month requires extensive cash management.
When the SSA needs to redeem securities for cash needs, ordering rules apply. Securities with the earliest maturity date are chosen first. If the trust fund owns more than one security with the same maturity date, then it chooses the security paying the lowest interest rate. For instance, in April, the trust fund acquired certificates of indebtedness worth $94.6 billion. However, at other times during the month, the trust fund also made three redemption requests totaling about $76 billion.
The intragovernmental nature of the investment of money from the Social Security Trust Fund is what spurs many skeptics to see the trust fund as a sham. However, the securities that the trust fund holds do exist, and they are obligations of the U.S. government to the same extent as any Treasury bonds issued to investors. When the money is needed, the trust fund simply redeems these securities and makes cash available to the SSA to cover its benefit payment obligations.
Social Security can therefore rely on getting its $2.8 trillion back from its trust fund whenever it needs the money for benefits. With projections suggesting that trust fund assets will diminish between now and the mid-2030s, Americans will get to see firsthand how the process of redeeming special government securities from the trust fund actually works in practice.
The article When Will Social Security Get Back the $2.8 Trillion It's Owed? originally appeared on Fool.com.
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