This Trio of Solutions Could Fix Social Security

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Social Security is arguably the most important social program for seniors. Without the monthly income that the program provides, many retirees could struggle to make ends meet.

Recently released data from the Social Security Administration showed that more than three in five (61%) seniors relies on Social Security to provide at least half of their monthly income, including almost three-quarters of all unmarried elderly retirees. The health and survival of Social Security is incredibly important to the financial well-being of our nation's retirees.

Unfortunately, Social Security isn't doing well. The architects of Social Security in the 1930s never foresaw the rapid rise in baby births following World War II, nor did they accurately predict the incredible rise we've witnessed in life expectancies since the mid-1960s. Combined, the retirement of baby boomers and a nine-year life expectancy increase over 50 years, is pushing the Social Security program to its limits.

By the year 2034, according to the latest forecast from the Social Security's board of trustees, the program will have exhausted its more than $2.8 trillion in spare cash, leading to what the Trustees predict could be an across-the-board benefits cut of up to 21% to sustain the program through 2090. Benefit cuts simply aren't an option for the aforementioned majority of seniors who count on Social Security as their primary source of income in retirement. The program needs a fix, and the longer Congress waits, the more burdensome implementing a fix could be.

The real kicker of the entire situation is that Congress has plenty of available solutions. Earlier this year, we highlighted 15 of them (albeit there are more we didn't mention). Some solutions provide a guaranteed fix, such as raising payroll taxes on all workers across the board right now. However, an across-the-board tax hike is a solution most working Americans want to avoid.

These three solutions could combine to fix Social Security

So how do you go about fixing Social Security while preserving benefits for the lower- and middle-income retirees who need it most? If I were in the driver's seat, this would be the trio of solutions I'd implement.

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1. Raise the payroll tax earnings cap

While all Social Security solutions have their positives and negatives, the most popular fix among the public in an informal Washington Post poll in 2014, raising the payroll tax earnings cap, makes sense. In that poll, 69% of readers agreed that they could stand behind the idea of raising the payroll tax earnings cap, whereas none of the other 11 solutions managed to garner higher than 44% support from readers.

As of 2016, earned income up to $118,500 was taxed by Social Security at 12.4%. This is a tax that's often split down the middle between you and your employer, but which is paid in full by self-employed persons. The reason this solution gets so much support is that most workers (nearly nine in 10) make less than $118,500 per year. This means they're paying tax on every cent they earn, while earned income above $118,500 is free and clear of being taxed by Social Security. Raising the payroll tax cap would only affect a small percentage of the population and require that wealthier individuals pay more into the program. This is the idea currently being supported by Democratic presidential nominee Hillary Clinton and running mate Tim Kaine.

The downside of boosting the payroll tax cap is that well-to-do individuals aren't going to see commensurate increases in their own Social Security benefits when they retire by contributing more to the system. Remember, monthly payments from the program are capped at $2,639 a month in 2016. In this respect, it's disadvantageous to upper-income individuals. However, the added income from raising the payroll tax cap could extend the spare cash exhaustion date of the program, ensuring that benefits won't be cut anytime soon.

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2. Freeze COLA for upper-income retirees receiving benefits

Another (largely unpopular) idea that's been proposed is to freeze Social Security benefits at 2016 levels for all retirees. Doing so would cover the budgetary shortfall in the program, but it'd crush the lower- and middle-class retirees that rely on cost-of-living adjustments (COLA) to keep up with the rising cost of housing, food, and other expenses.

A softer and more amiable solution that could further push back the date of the program's spare cash exhaustion is to freeze COLAs for say the upper 30% to 50% of income earners in retirement. Chances are better than not that well-to-do individuals and couples have the financial means to withstand a freeze in their monthly benefits since they're more likely to have secondary channels of income, such as a retirement account, than a lower-income individual or couple. The money saved by not having to provide COLAs to upper-income deciles would ensure that lower-income, and most middle-income, deciles get a regular COLA, should one be doled out.

Keep in mind, though, that freezing COLA on wealthier individuals isn't a perfect solution. Married couples where one spouse has a large disparity in lifetime earnings to the other spouse could be adversely affected. COLA for the lower-income spouse simply won't make up the difference caused by a freeze in COLA for the higher-income spouse, thus hurting the combined retirement income of the couple. However, this seems to be a more amiable solution for upper-income individuals and couples than pure means-testing, which would deny Social Security benefits to persons who have too much income.

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3. Adjust the taxation of Social Security benefits to reflect inflation

A final suggested solution would be to adjust the way Social Security benefits are taxed by the federal government.

It may not be a well-advertised fact, but Social Security income is subject to taxation if you earn too much money in a given year. According to the IRS, up to 50% of your Social Security income becomes taxable if you earn more than $25,000 as an individual or $32,000 as a couple in 2016. Furthermore, up to 85% of your Social Security benefits becomes taxable if you earn more than $34,000 as an individual or $44,000 as joint filers.

But, what's often overlooked with these tax levels is that they haven't been adjusted for inflation in 33 years! The initial tax that exposed up to half of a retiree's benefits to federal taxation was implemented in 1983 and expected to affect about one in 10 households. The additional bracket that exposed up to 85% of Social Security benefits to federal taxation was added a decade later, in 1993, during the Clinton administration. It was noted at the time that only 18% of retiree households would be affected. Here we are, though, 33 years after the first tax was introduced and well over half of all retirees receiving Social Security income are paying some level of tax on their benefits, according to the Senior Citizens League.

The solution is simple: Take into account 33 years' worth of inflation and make the correction to these tax thresholds. Doing so would put more money back in the pockets of middle-income seniors while reducing program revenue by a negligible amount.

I'd opine this trio of solutions is crazy enough to work, but it's far from the only set of solutions to fix Social Security. How would you tackle fixing America's most important social program?

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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.

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