Is Social Security Really a Ponzi Scheme?

Whether you're currently retired or set to hang up your work coat at some point in the future, there's a very good chance that you'll be in some way reliant on Social Security income to make ends meet. Today, 90% of existing retirees lean on Social Security as a major or minor income source, with just 1 in 10 able to live comfortably and pay their bills without it. As for future retirees, a survey from Gallup in April 2018 found that more than 4 out of 5 will rely on Social Security as either a major or minor source of income when retired.

That's what makes what I'm about to say very worrisome: Social Security's long-term outlook is in peril.

Social Security's problems lead to rampant misconceptions

According to the newest annual report from the Social Security Board of Trustees, America's most important social program is set to undergo an unwelcome transformation in 2018 that'll see it expend more than it collects in revenue for the first time since 1982. This net cash outflow is expected to pick up steam in 2020 and beyond, ultimately leading to the projected depletion of the program's $2.89 trillion in asset reserves by 2034. Should Congress fail to act, a reduction in benefits for then-current and future retirees of up to 21% may be needed to sustain payouts through 2092. It's a truly concerning outlook considering that more than 3 out of 5 retired workers currently rely on Social Security for at least half of their monthly income.

Making matters worse, Social Security's shortcomings are the source of countless misconceptions about the program. For example, some folks have postulated that Social Security's cash shortfall is derived from Congress continually borrowing money from the program's asset reserves. This, of course, is completely false. Every cent of Social Security's excess cash is accounted for by the special-issue government bonds that the program holds. Not only that, but Social Security also generates tens of billions of dollars in interest on its asset reserves each year -- income that's proven vital to keeping the program net cash positive since the beginning of the decade.

Another common misconception is that immigration is responsible for draining Social Security's coffers. This, too, is untrue. In reality, legal immigrants tend to be younger and, therefore, more likely to work for decades before qualifying for a retired worker benefit. This means their contribution to the payroll tax is vital to the health of Social Security. Similarly, since undocumented immigrants are unable to obtain a Social Security number, they are ineligible for benefits.

Is Social Security a Ponzi scheme?

But one of the more common accusations about Social Security is that it's nothing more than a Ponzi scheme destined for bankruptcy.

A Ponzi scheme is a form of fraud that typically promotes high rates of return with minimal risk in order to drive investment into a fund or entity. Early investors are paid off with a handsome return by using the investment money provided by more recent investors. It's the scheme Bernie Madoff and Robert Allen Stanford used to swindle billions of dollars out of their investors over a long period of time.

But does this aptly describe what's going on with Social Security? Not even close.

Social Security is an investment in our elderly labor force who can no longer provide for themselves financially, but it's not an investment vehicle, an entity that seeks to profit, or defrauding the American public in any way.

Social Security is funded by a 12.4% payroll tax on earned income of up to $128,400 (in 2018), the taxation of Social Security benefits, and the interest income earned on its asset reserves. The money the program brings in, with the exception of its excess cash being used to purchase special-issue government bonds, as required by law, isn't being invested in stocks, real estate, or other speculative/high-growth areas.

Additionally, Social Security isn't attempting to profit in any way. The annual budget to run Social Security typically accounts for only 0.6% to 0.7% of all revenue collected. Last year, out of $996.6 billion collected, the Social Security Administration's operating budget was just $6.5 billion. This means that around $0.99 of every $1 collected is going right back out as a benefit to eligible recipients.

And, as noted, the money Social Security collects, expends, and purchases bonds with as required by law is completely accounted for. Not a red cent has disappeared, and Congress certainly hasn't absconded with any money in the program.

Yes, Social Security is designed to protect the elderly with the payroll taxes of younger working Americans, but that's a social investment, not an economic one. And that's why Social Security can, in no way, be accurately described as a Ponzi scheme.

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