Social Security's Got an $11.4 Trillion Problem

By Markets Fool.com

Image source: Flickr user Pedro Ribeiro Simones.

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Social Security's trustees recently issued their annual report and in it were startling revelations about the program that every current and would-be retiree ought to know. Among a slate of stunning statistics packed into this report, perhaps the most worrisome is the $11.4 trillion (yes, trillion) unfunded obligation that the program faces over the next 75 years.

Digging into the details

Social Security is a major source of retirement income for millions of Americans. More than 60 million people count on Social Security checks to pay bills every month. For many, Social Security supplements other retirement income, but for nearly half of all single retirees, Social Security represents 90%, or more, of their income.

Social Security's importance as a safety net for seniors is unquestionable. However, the program's ability to provide financial security to retirees is in jeopardy.

Social Security is a pay-as-you-go system. This means that payroll taxes collected on worker wages are used to pay benefits to current recipients. This system works when the population of workers is handily bigger than the population of retirees, but it fails miserably when the ratio of workers to seniors drops.

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Unfortunately, that's exactly what's happening. From 1974 through 2008, the worker-to-recipient ratio remained relatively steady between 3.2 and 3.4. However, the ratio has fallen to 2.8 since, and as more of the 76 million baby boomers exit the workforce, it's expected to drop to 2.2 by 2035.

Number of covered workers per beneficiary by decade, 1980-2090. Source: Social Security Administration.

The decline in workers relative to retirees in the past seven years has led to payments to Social Security recipients outstripping payroll tax revenue since 2010.

Fortunately, the gap between tax revenue and outlays is currently being bridged by the Social Security Trust Fund, a $2.8 trillion fund that was built up during the years when the worker-to-retiree ratio was higher.

Unfortunately, the gap that's being filled by the trust fund will widen considerably as more boomers stop working. In 2015, payroll taxes produced $679.5 billion in revenue to fund Social Security, but Social Security paid out $743 billion to recipients. As that gap widens further, the trust fund will continue to make up the difference until it runs dry in 2034.

Assuming no changes are made to shore up Social Security's financial future, the trustees determined that the present value of unfunded obligations owed to retirees over the next 75 years totals $11.4 trillion.

Social Security Trust Fund cumulative reserves (2015-2033) or gap (2034-2090). Source: Social Security Administration.

What does that mean for retirees?

When the Social Security Trust Fund runs out of money in 2034, revenue generated from payroll taxes will only cover 79% of the program's cost. This means that if Washington fails to act, benefits would need to be cut by 21% across the board for Social Security to remain solvent.

A 21% cut in benefits would be a deal breaker for millions of American retirees, but there are options available to lawmakers.

According to the trustees, Social Security solvency would be guaranteed if Washington does any of the following:

  • Increases the payroll tax permanently by 2.58%.
  • Reduces benefits immediately and indefinitely by 19% for everyone retiring this year and in the future.
  • Or embraces some combination of those two options.

Image source: Getty Images.

Looking ahead

Paying more in payroll taxes may be more palatable to the tens of millions of retiring baby boomers who have long planned on receiving Social Security and have paid into the system for decades. One possible solution that's being considered to boost tax revenue is to lift the income cap that payroll taxes currently apply to. Presently, payroll taxes are collected on earned income up to $118,500.

However, tax increases are never popular, and Washington may attempt to prevent them by embracing policies that could reduce payments, such as increasing the age at which retirees can claim Social Security and eliminating Social Security payments to high-income earners.

Regardless of what option Washington settles upon, Social Security's trustees warn that time is of the essence. In their words, if Washington kicks the can down the road, "the changes necessary to maintain Social Security solvency become concentrated on fewer years and fewer generations." Ostensibly, that means more drastic tax increases or cuts would be needed in the future.

The article Social Security's Got an $11.4 Trillion Problem originally appeared on Fool.com.

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