The annual Trustees Report for Social Security delivers good news and bad news about the program's financial reserves.
Here’s the bad news: according to the latest estimate, Social Security will be “insolvent” by 2033.
Now the good news: that’s the same bad news the report said last year. In other words, things did not get worse.
Pessimists will be quick to point out that 2033 is three years sooner than the 2011 projection of 2036, but that was before the impact of Great Recession was fully realized and factored into the annual calculations that Social Security’s actuaries perform. Three consecutive years of an unemployment rate of 9% and higher brought a financial double-whammy: Fewer people in the workforce caused a decline in Social Security’s income (the payroll tax that it collects) along with the unexpected increase in the amount benefits the fund had to pay out as laid-off older workers filed earlier than predicted because they couldn’t find re-employment.
Other factors also affected Social Security’s long-term financial outlook, but those were the two biggest, and the fact that the situation has stabilized in the past year is a good thing.
Back to the Future
Let’s look at what’s meant by the term “insolvent.” First, it does not mean that Social Security is, as some have said, “going broke.” When used to describe the Social Security system, “insolvent” means that the program will not collect enough in payroll tax to fully cover the estimated benefits it will pay out in a given year. If no changes are made, it is estimated that in 2033 Social Security will have used up the extra assets it was accumulating in the Trust Fund to help cover the cost of retiring baby boomers. At that point, Social Security can only pay out in benefits what it collects via payroll tax, which has been estimated to be roughly 75% of the amount it will be obligated to pay. (1)
While 75-cents on the dollar isn’t great, it’s far better than zero.
What’s causing the situation? The continued decline in the number of people in the workforce compared to our growing and aging population.
We’ve been here before.
Shortly after taking office in 1981, President Ronald Reagan was told that Social Security would be in solvent by 1983- just two years away. In response, Reagan appointed a presidential commission (headed by a then unheard-of economist named Alan Greenspan) to come up with a solution. The double-digit inflation experienced in the 1970s along with periods of high unemployment had caused benefits to go up and Social Security’s income to fall.
But the bigger issue was the product of two long-term trends that were not expected to change: 1) an increase in life expectancy, resulting in retirees collecting benefits longer than they used to, and 2) the end of the baby boom, meaning fewer new workers would be entering the workforce in coming years. To address these and other issues, the so-called “Greenspan Commission” made a slew of recommendations. These eventually became the Social Security Amendments of 1983 and, among other things, included gradually raising the full retirement age from 65 to 66 and eventually 67, as well as increasing the payroll tax rate.
Pause for a moment and consider this: with a few tweaks along the way, Social Security has worked just fine for the past 30 years. We are simply approaching the point where we need to make adjustments once again. And, unlike Reagan, politicians today have 20 years- not two- to come up with a solution!
What Would You Say?
The changes needed to the fund are not as draconian as some (usually those with political motives) would like you to think. According to the recently-released trustees report, we could solve the funding problem for Social Security for the next 75 years by increasing the payroll tax 2.72%. In other words, if we only attacked this from the taxation side, it would mean raising the payroll tax from its current rate of 12.4% to 15.12%.
Done. Problem solved.
While no one likes a tax increase (which is why our leaders in Washington, D.C. will never bring this up), would this really be the end of the world? Consider that the payroll tax is evenly split between employer and employee. A 2.72% increase would amount to each side paying about 1.3% more. As Alicia Munnell, director of the Center for Retirement Research at Boston College, points out: workers saw their payroll tax rate go up a full 2% at the beginning of the year and there was no great hue and cry.(2)
Though it’s admittedly not statistically valid, I’ve been conducting my own survey. I simply ask folks of all ages and walks of life, “Would you be willing to contribute 1.3% more to Social Security if this meant that everyone would get what’s coming to them for the next 75 years?” Without exception, every single individual says “Yes.”
Try it yourself. Ask your neighbors, co-workers, family members. I’d be shocked if you didn’t get the same result. That’s how important it is for people to feel secure that Social Security will be there.
Stop Blaming the Baby Boomers
“The Pig-in-the-Python [analogy] just isn’t true,” says Munnell. In fact, the average age of the U.S. population has been increasing since the founding of our country, thanks to a long-term decline in fertility coupled with a long-term increase in aging. “It started before baby boomers were born and will [eventually] reach a stable level where the ratio of older-to-younger people will be constant,” says Munnell.
In other words, the situation Social Security is facing today would have happened anyway. Baby boomers simply accelerated the timing of it. As you can see below, if you assume the last boomer lives to be 100 (2065), Social Security will still be facing a funding shortfall if nothing is changed.
“Do Nothing” Is Not An Option
Despite the results of my personal poll, it’s unlikely this issue will be attacked simply through raising the payroll tax rate. Studies by various think tanks have demonstrated that a combination of tiny changes to the many factors and assumptions that go into Social Security’s calculations would close the funding gap without putting the entire burden on any single group, such as the ever-popular “wealthy.” Increasing the full retirement age to 68 is one possibility. In fact, this is already the norm in Great Britain if you are a government worker. There’s also been a lot of discussion about changing the way Social Security benefits are adjusted for inflation.
But all of the extremist rhetoric about the demise of Social Security is only unfair to the American people. We deserve better from our so-called “leaders.” Such as leading- instead of playing politics with Social Security. “It’s scaring people,” says Munnell. “It’s too bad. Social Security is the backbone of our retirement system. Most people don’t have anything else. It should be one of our highest priorities.”
Coming up next week: How the scary things we’re hearing about Social Security are causing people to make bad decisions about how and when to claim their benefits.
1.By law, Social Security cannot pay out more in benefits than it collects via payroll tax.
2 After nearly two years, the so-called “tax holiday” that was supposed to stimulate the economy expired at the end of 2012. Under its terms, the employee’s half of the payroll tax was temporarily reduced by 2%- from 6.2% to 4.2%. (To prevent a negative impact on Social Security’s finances the Treasury Department was ordered to make up the loss in revenue from general funds.)
Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content.
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