Whether you're already retired, nearing retirement, or even if you won't hang up your proverbial work coat for decades to come, chances are good that Social Security will play a role in your financial well-being during retirement. Among current retired workers, 62% rely on the program for at least half of their monthly payout, with 84% of surveyed nonretirees expected to lean on Social Security in some capacity during their golden years.
Given this data, you'd think that ensuring the health of Social Security for current and future generations of beneficiaries would be paramount for lawmakers on Capitol Hill. Instead, the program is inching closer to disaster, according to the 2018 Social Security Board of Trustees' annual report.
Continue Reading Below
Social Security is facing a $13.2 trillion cash crunch
Contained within the latest report was a prognostication no different from the last 33 that came before it: Social Security won't generate enough revenue over the next 75 years to maintain the existing payout schedule. The latest figures call for outlays to outpace revenue collection very soon, with the program's nearly $2.9 trillion in asset reserves being completely depleted by the year 2034.
The silver lining for current and future retired workers is that this doesn't mean the end of Social Security. The 12.4% payroll tax on earned income (up to $132,900 in 2019) and the taxation of benefits will still generate a lot of revenue that can be distributed to eligible beneficiaries. But that bad news is that it means the existing payout, including cost-of-living adjustments (COLA), isn't sustainable. In fact, the Trustees forecast the need to cut benefits by up to 21% in 2034 to sustain payouts over the next 75 years.
In other words, the American public is looking to their elected officials in Washington, D.C., to get to work and resolve Social Security's $13.2 trillion cash shortfall between 2034 and 2092. The big question has been "How best to tackle the issue?"
On one hand, Democrats have proposed addressing Social Security's shortcomings by raising revenue, primarily through increased taxation on upper-income earners. On the other hand, Republicans have favored the idea of reducing long-term expenditures, or as most folks refer to it, "cutting Social Security benefits." But ask most Americans what "cutting Social Security" entails, and you'll probably either get a bunch of confused looks or a bevy of wrong answers.
With that being said, let's dive into the logistics of the GOP proposal to reduce long-term expenditures and explain what cutting Social Security benefits over the long run would actually look like.
Understanding what Social Security cuts would actually look like
To begin with, cutting Social Security benefits doesn't mean simply taking the scissors and cutting a portion out of everyone's benefit check. Rather, there are two direct changes that Republicans would make to the Social Security program that would partially impact existing retirees, but place far more of a burden on future generations of retired workers.
1. A gradually increased full retirement age
The first change is the proposal to gradually increase the full retirement age, or the age at which you become eligible to receive 100% of your monthly benefit. The peak full retirement age is 67 for anyone born in or after 1960. However, GOP lawmakers have suggested gradually increasing this figure to as high as age 70 for future generations of workers. In doing so, it would protect the payouts of those folks who are already retired or near retirement, but it would potentially require Generations X, Y, and Z to wait longer to receive their full payout, or to claim early and accept a steeper monthly reduction to their benefit. Regardless of the path these future retirees choose, it should result in lower lifetime benefits being paid out, thereby reducing program expenditures.
Why target the full retirement age, you wonder? Since the Social Security Act was signed into law in 1935, and through 2022, which is when the full retirement age will cap at age 67, the full retirement age will have risen by just two years (from 65 to 67). Yet, the average life expectancy in the U.S. has risen at a considerably faster pace over this same period. This has meant that instead of Social Security providing a financial foundation for perhaps a few years or a decade, it's now leaned on for two decades by the average 65-year-old. Increasing the full retirement age would, presumably, help combat Social Security's longevity problem.
2. A shift in Social Security's annual COLA calculation
The second change Republicans would make is instituting a new inflationary tether tied to the program's COLA (COLA is the "raise" passed along to beneficiaries each year to keep up with inflation). Rather than the Consumer Price index for Urban Wage Earners and Clericals Workers (CPI-W), which, frankly, both political parties dislike, the GOP would utilize the Chained CPI as its inflationary tether.
If this inflationary index sounds somewhat familiar, it's because the Chained CPI is what's now used to calculate inflation for federal income tax brackets and credits, following passage of the Tax Cuts and Jobs Act in December 2017. Republicans have long pushed for the Chained CPI as Social Security's inflationary measure, and with the Tax Cuts and Jobs Act now law, that chatter has grown even louder.
The Chained CPI takes into account the idea of substitution bias. If, for instance, you were in the supermarket and noticed that ground beef prices had risen 40%, you might decide to trade down to a similar item, such as pork or chicken, which are less pricey. This is an example of substitution bias in action, and it does represent a real consumer buying behavior. Unfortunately, since the CPI-W does not currently factor in substitution bias, switching to the Chained CPI would result in lower annual COLAs. In the short term, a slightly lower COLA may not be noticeable. Over a long period of time, lower COLAs would save the program substantial amounts of money, but would wind up further reducing the purchasing power of Social Security dollars for all current and future beneficiaries.
So, to recap, cutting Social Security doesn't mean everyone suddenly has "X" amount taken out of their benefit check. Rather, it would mean a systemic change that would reduce the lifetime benefit potential of today's younger workers, and exacerbate the loss of purchasing power already being felt by existing and future retirees.
Should some degree of cost-cutting be part of the long-term solution for Social Security? That's up to you and your elected congressional representatives to decide.
The $16,728 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 $16,728 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.