Social Security Is Failing Because the Program Is Antiquated

By Sean Williams Markets Fool.com

The data doesn't lie: a majority of seniors rely on Social Security to meet their month-to-month expenses come retirement. According to the Social Security Administration (SSA), 61% of retired workers currently receiving benefits counts on those benefits to comprise at least half of their monthly income.

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But this vital source of retirement income is also causing retired workers, pre-retirees, and tens of millions of working Americans grief. The latest annual report from the Social Security Board of Trustees estimates that the program will begin paying out more in benefits than it's receiving each year in revenue by 2020, eventually resulting in the depletion of its more than $2.8 trillion in spare cash by 2034. If this spare cash is completely exhausted, the Trustees have implied that a benefits cut of up to 21% could be needed on an across-the-board basis (i.e., for current and future retirees) in order to sustain payouts through the year 2090. That's not a comforting outlook for the aforementioned majority of retired workers who count on Social Security each month.

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Social Security's biggest problem is that it's antiquated

If there's one thing Social Security isn't short of, it's finger-pointing as to why the program is headed down an unsustainable path. Some blame the baby boomer generation for their poor saving habits and early Social Security claims, which are expected to weigh heavily on the worker-to-beneficiary ratio. Others point to lengthening life expectancies, or the political divide in Washington. There's no shortage of blame to go around.

However, the real blame for Social Security's seemingly imminent budgetary shortfall can probably be placed on lawmakers who've chosen to allow an antiquated program to take care of our nation's retirees.

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Social Security was signed into law more than 81 years ago in Aug. 1935. When the first payment was made in 1940, senior citizens weren't living anywhere near as long as they are now. Additionally, the costs that comprised a good chunk of today's expenditures for retired workers (housing and medical care) weren't outpacing inflation by much, if anything, in the 1940s.

The last significant overhaul to the Social Security program came during the Reagan era with the passage of the Amendment of 1983. These Amendments introduced the taxation of Social Security benefits, and increased the full retirement age (the age at which an individual becomes eligible to receive 100% of their monthly benefit) in the decades to come, to name a few of the changes.

While there have been some changes to the Social Security program since 1983, there's been no major overhaul to the extent of the 1983 Amendments.

Now, here's what today's seniors are left with.

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1. The taxation thresholds haven't been adjusted for inflation in 34 years

The first issue is that the income thresholds that define what portion of Social Security benefits are taxable haven't been updated in 34 years to account for inflation! When first introduced in 1983, individuals with earned income over $25,000, and joint filers with earned income above $32,000, could have 50% of their Social Security benefits taxed by the federal government. A decade later, the Clinton administration added another tax tier, allowing 85% of Social Security benefits to be taxed if a recipient's annual income topped $34,000, or $44,000 for joint filers.

In 1983 and 1993, these taxation changes affected around 1-in-10, and nearly 1-in-5 households with seniors. By 2015, according to The Senior Citizens League, 56% of seniors owed at least some tax on their Social Security benefits. Had these thresholds kept pace with inflation, individual tax filers wouldn't be hit until $57,107 (in 2015 dollars), and couples until $73,097.

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2. The full retirement age hasn't kept pace with life expectancy increases

Another issue with the Social Security Amendments of 1983 is that they phased in a two-year full retirement age increase over what amounted to a four-decade period. Beginning in 2017, the full retirement age will rise by two months per year, ultimately moving from age 66 to age 67 between 2016 and 2022 (the full retirement age of 67 applies to anyone born in 1960 or later). In other words, between 1983 and 2022, the full retirement age will have increased just two years.

However, actual life expectancies since 1983 have risen at a quicker pace. Data shows that the average life expectancy in 1983 was 74.6 years, compared to 78.8 years in 2015 according to the Centers for Disease Control and Prevention, an improvement of 4.2 years in 32 years. A slower-growing full retirement age means retired workers are potentially collecting Social Security for a longer period of time than ever before, which is weighing on the program.

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3. More income than ever is escaping Social Security's payroll tax

It's probably also fair to say that quite a bit of wealthy Americans' income is escaping Social Security's payroll tax. As a refresher, Social Security's payroll tax, which totals 12.4% and is often split down the middle between you and your employer, covers earned income between $0.01 and $127,200 as of 2017. This means earned income above and beyond $127,200 is free and clear of the payroll tax.

However, a quick look at the SSA's wage distribution statistics from 2015 shows that 137,545 people earned at least $1 million. These individuals would have paid an aggregate of about $16.3 billion in payroll taxes in 2015 (based on the cap of $118,500 that year). However, these millionaires earned an aggregate of $340.8 billion in income in 2015. That's over $324 billion dollars that escaped taxation because the maximum taxable earnings cap has been stuck growing at a snail's pace (it's tied to the Average Wage Index). And remember, I'm not including earned income between $118,500 and $999,999 in these figures, either. In other words, the program could be bringing in a lot more money for future generations of retirees if the payroll tax cap were adjusted.

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4. Social Security's COLA is inadequately taking into account the high expenditures seniors face

Lastly, the cost-of-living adjustment (COLA) that seniors receive most years (i.e., their inflation-based raise) isn't coming anywhere close to reflecting the true inflation they're dealing with when it comes to housing costs and medical care inflation. A quick review of medical care inflation and Social Security's COLAs over the past 35 years shows that medical care inflation was higher in 33 of 35 years. This makes it practically impossible for seniors to make do with what they're being paid since more of their income is going to pay for their medical care with each passing year.

Lawmakers are attempting to make a program that was developed in the 1930s and tinkered with heavily in the 1980s work for seniors in 2017 -- and it's clearly not working. Change can only come from Washington, but that'll only happen once lawmakers realize that a good portion of the program, both from the revenue and benefits sides of the equation, needs to be refreshed for today's senior citizens.

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