This Hasn't Happened to Social Security in 36 Years

By Sean Williams Markets Fool.com


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Social Security plays a vital role in the financial well-being of many of our nation's seniors. According to national pollster Gallup, around 60% of current retirees who are taking Social Security benefits rely on those benefits in a "major" way each month. A similar question posed to baby boomers, who are in the process of transitioning out of the workforce and will be doing so for at least another decade, showed a relatively similar expected reliance on the income Social Security provides during retirement.

But Social Security isn't without its problems. The program that seniors have leaned so heavily on for decades is expected to burn through its more than $2.8 trillion in spare cash by the year 2034, at least according to the latest predictions from the Social Security Board of Trustees. If Congress can't figure out how to make the program's budgetary shortfall disappear, current and/or future beneficiaries could see their monthly benefit checks cut by up to 21%. It's not exactly a dream scenario with so many retirees and pre-retirees expected to be reliant on Social Security income.

Hands-down the most popular Social Security fix

While there are more than a dozen ways to partially or fully fix Social Security, the one adjustment that a majority of Americans seem to agree on is raising the payroll tax earnings cap.

All American workers pay a 12.4% payroll tax on their wages, with most workers splitting the responsibility of this tax with their employer (6.2% each). In 2016, the payroll tax applied to wages earned between $1 and $118,500. Any wages beyond $118,500 were free and clear of the payroll tax.

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Whereas most workers are stuck paying into Social Security on every dollar they earn throughout the year, the well-to-do only have to pay into the program on a percentage of their earnings, assuming they earned more than $118,500 in 2016. Raising the payroll tax earnings cap would require the wealthy to pay more into Social Security without having any impact on more than 90% of the workforce, which is already paying into the program with every dollar they earn.

One of the biggest proponents of a payroll tax earnings cap increase was former presidential candidate Hillary Clinton. During her campaign, Clinton had called for lifting the payroll tax cap to roughly $250,000. Doing so would have provided a payroll tax moratorium between the current payroll tax earnings cap and $250,000. However, any wages earned beyond $250,000 would once again be hit with the 12.4% payroll tax (or 6.2% if you're employed by someone else).

This hasn't happened in 36 years

As we know, Clinton lost the November election to Donald Trump, so her solution to lift the payroll tax earnings cap was pushed to the wayside. However, it didn't entirely get put out to pasture.

As announced in October, the Social Security Administration made a number of changes to Social Security in 2017, including raising the payroll tax earnings cap from $118,500 in 2016 to $127,200, a 7% increase that'll have well-to-do employees paying an additional $539 into Social Security this year. If this seems like an exceptionally large increase to the payroll tax earnings cap on a percentage basis, you'd be correct. It's the first time since 1981 -- that's 36 years for you math-phobic people -- that the payroll tax cap has jumped by such a large percentage.


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Why such a large increase? The maximum taxable earnings figure is tied to the National Average Wage Index, which happened to rise 3.6% in 2014 and 3.5% in 2015, the most recent year for which the benchmark is available. However, rules built into Social Security disallow an increase to the maximum taxable earnings when there's no corresponding cost-of-living adjustment (COLA). This means in three of the past eight years when there was no COLA, a result of a decline in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), there was also no increase in the maximum taxable earnings.

After the steepest recession in 70 years there has still been minimal wage growth, so even after three years of static maximum taxable earnings, the fourth year saw only a modest increase in wages and maximum taxable earnings. But with the economy clicking on all cylinders at the moment, and the CPI-W declining because of falling oil prices the previous year, the maximum taxable earnings were ripe for a sizable increase.

The bright side is that only 12 million workers, or about 7% of the labor force, will be affected by the increase in the payroll tax cap. For the remaining 161 million workers, the increase has no bearing whatsoever. As long as wage growth continues to impress, there's a good chance that the wealthy will be required to pay a little bit extra into Social Security with each successive year.

More needs to be done

While an increase in the maximum taxable earnings could put a little more pep into Social Security's step in 2017, it's not a long-term fix for the program. In fact, raising the payroll tax earnings cap to say $250,000, or eliminating the cap entirely and taxing all wages, still wouldn't be enough to rid Social Security of its budgetary shortfall. More work is going to be needed beyond just adjusting the payroll tax earnings cap.


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What else might be in order? According to the "Voice of the People" survey, 79% of registered voters were in favor of raising the full retirement age if it meant preserving Social Security for future generations.

Your full retirement age, which is determined by your birth year, is the age where you become eligible to receive 100% of your benefits. If you claim benefits before reaching your full retirement age, you'll receive less than 100% each month. Conversely, signing up after your full retirement age means a bigger benefit. Adjusting the full retirement age higher to age 68, 69, or even 70, would affect all future retirees by causing them to wait longer to receive their full benefit, or reducing their payout.

Combined with a payroll tax earnings cap increase, this combination of revenue increase and benefit cuts could work in ebbing Social Security's shortfall. However, the final say is up to Congress, and who knows when exactly lawmakers on Capitol Hill will agree on a solution.

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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.The Motley Fool has adisclosure policy.