A Big Social Security Change Is Coming in 2020, and You Probably Aren't Aware of It

By Sean Williams Markets Fool.com

Social Security is, for many retired Americans, a financial foundation that they'd struggle to live without.

Continue Reading Below

A study conducted by the Center on Budget and Policy Priorities (CBPP) found that the elderly poverty rate inclusive of Social Security benefit payments is 8.8%. Without these payments, the CBPP estimates that senior poverty rates would shoot above 40%! Based on the more than 41 million retired workers receiving a monthly benefit as of March, we'd be talking about an increase in the elderly poverty rate of more than 12 million people. That's no insignificant figure, and it demonstrates the importance of this program.

Image source: Getty Images.

There's a big Social Security change that's just three years away

But as many of you may have heard by now, Social Security is on a collision course with disaster. According to the Social Security Board of Trustees 2016 report, the Trust's more than $2.8 billion in excess cash will be completely exhausted by 2034. Once this money is gone, the Trustees have estimated that across-the-board benefit cuts of as much as 21% may be needed to sustain payouts through the year 2090.

What you may not realize is that a big change that'll precipitate this cash downfall is right around the corner. Beginning in 2020, per the Trustees' estimates, Social Security will begin paying out more in benefits than it's generating in revenue. In other words, the switch will officially beflipped, and the more than $2.8 trillion spare cash pile will begin to dwindle.

Continue Reading Below

Why, you ask? There's no one specific reason. Rather, it's a confluence of factors that include:

  • The ongoing retirement of baby boomers, which will lower the worker-to-beneficiary ratio
  • Lengthening life expectancies, which allows people to claim benefits for an extended period of time
  • The rich, who are living noticeably longer than lower-income folks and are able to draw a (large) benefit payment for a longer period of time
  • America's poor saving habits, which coerce workers and seniors to be extra reliant on Social Security during retirement

Image source: Getty Images.

Say goodbye to over $90 billion in annual program revenue

Yet, there's another issue not mentioned above.

Social Security has three means by which it generates revenue:

  • Payroll taxes
  • Interest income on its spare cash
  • The federal taxation of benefits

Payroll tax helps funds Social Security at a rate of 12.4% of earned income between $0.01 and $127,200, although most workers only pay 6.2%, with their employer covering the other half. This maximum taxable income figure of $127,200 changes in step with the average wage index most years. In 2015, payroll taxes accounted for 86.4% of the $920.2 billion in revenue collected for Social Security.

The federal taxation of benefits amounted to about 3.4% of total revenue in 2015. Social Security recipients with incomes above $25,000 or joint filers with income above $32,000 are subject to having at least half of their benefits exposed to federal taxation.

The final 10.1% (the numbers don't add to 100% due to rounding) is comprised of interest income from its more than $2.8 trillion in spare cash. This cash is invested in special issue bonds designed for trusts and, to a far lesser extent, certificates of indebtedness. In 2015, nearly $93 billion in revenue was generated by this spare cash.

But beginning in 2020, this spare cash will start to dwindle -- and as it dwindles, so will the interest income generated for the program. Higher interest rates could help ebb the pain a bit since it will mean higher yields on the aforementioned special issue bonds, but it's not going to do enough to prevent the program from running out of excess cash by 2034.

Image source: Getty Images.

The two most popular Social Security solutions are at opposite ends of the spectrum

Now, this is where things get interesting. It's not as if Congress doesn't have effective ways to fix Social Security's more than $11 trillion, 75-year budgetary shortfall. It does. The issue is simply that Democrats and Republicans both have an effective fix, and neither wants to cave in to the other party's solution.

The Democrats' thesis is that the wealthy should shoulder more of the load. As noted above, the maximum earnings cap as of 2017 prevents the payroll tax from being applied to earned income above $127,200. Democrats have suggested lifting this earnings tax cap to a figure between $250,000 and $400,000 (essentially giving earned income between $127,200 and $250,000-$400,000 a free pass, then reinstituting the payroll tax), or even removing the cap altogether and taxing all earned income.

Removing the payroll tax earnings cap altogether would only impact about 10% of the population, which is what makes it such a popular choice among the public. It would also completely eliminate the program's cash shortfall.

At the opposite end of the spectrum, Republicans have been pushing the idea of raising the full retirement age, or FRA. Your FRA, which is determined by your birth year, is the age at which you become eligible to receive 100% of your retirement benefit. The FRA began increasing by two months per year in 2017 from 66 years, and it'll continue to do so until it hits 67 years by 2022.

Republicans have proposed further increasing the FRA to 68, 69, or 70 years to account for increased longevity. Raising the FRA forces seniors to wait longer to get 100% of their due benefit or to claim early and accept a steeper cut in benefits. This solution fixes Social Security's shortfall, too.

In order for Social Security to be fixed for the long term, we're probably going to need to see compromise with both sides meeting in the middle. But one thing is for certain: The longer Congress waits, the direr the situation could be for seniors.

The $16,122 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,122 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.

The Motley Fool has a disclosure policy.