Finances of Social Security are a disaster in the making

It’s one of the biggest fiscal problems the US is facing, one that politicians undoubtedly could remedy but likely will not fix anytime soon: Social Security.  

The forthcoming train wreck has been decades in the making, and, despite how painfully visible it is, people paying into the system today may not see the benefits they’ve been promised when they retire. Almost certainly, that will affect today’s younger workers more than those in or near retirement.  

The future of the program is so cloudy because talking about ways to get it back on track is politically unpopular at the present. While politicians, including President Joe Biden and former President Donald Trump, have pledged to protect Social Security, there have been few willing to explore the necessity of raising retirement ages, reducing future benefits, or hiking taxes.  

“This keeps getting kicked down the road,” said Mary Beth Franklin, a former InvestmentNews contributing editor who specializes in Social Security. “We know something has to be done, and when you have the presumed leaders of both parties saying they’ll do nothing, it doesn’t give Congress any cover.”  

That also doesn’t give financial advisors much clarity in the assumptions they use to help younger clients plan for retirement. For those who are retired or near retirement, advisors “can confidently assume that those benefits will continue to be there,” Franklin said. But for people many years from claiming Social Security, “you might want to say, ‘let’s stress-test your retirement income plan,’” with a scenario that could include a 20 percent or so reduction in future benefits.   

“If it’s a real problem, let’s start doing things in advance to get you in a better situation for the future,” she said.  

HOW DID WE GET HERE?  

The Social Security trust funds are expected to be fully depleted by 2034, at which point Congress would have to put emergency measures in place to ensure full benefits are paid out.  

Driving the trust funds’ exhaustion are several factors, the most significant of which is increased life expectancy. In addition, average income levels have been creeping higher, so the slice of total pay that’s subject to Social Security taxes is smaller.    

There’s also a surge of baby boomers heading into retirement – an issue that Congress saw coming back in 1983, when it enacted a major patch to fix the system. At the time, Democrats and Republicans both strongly backed legislation to start taxing up to 50 percent of Social Security income. Ten years later, a measure to increase to 85 percent the portion of benefits that could be taxed barely eked by, with then-Vice President Al Gore casting a tie-breaking vote.  

Since then, potential overhauls to the system have only become more politically unpopular. In no small part, that’s because Social Security income is viewed differently than other government programs in that it is an earned benefit.  

“It is framed differently from welfare,” said Andrew Biggs, a senior fellow at the American Enterprise Institute who served as principal deputy commissioner of the Social Security Administration under President George W. Bush. “This sort of moral framing of benefits is of paramount importance in understanding why Social Security is so difficult to fix. People have been made promises.”  

Unfortunately, those promises involve a mismatch between money put in and the benefits to be paid out. For people born in the 60s, the benefits being promised are 37 percent higher than the taxes paid during their working years, plus interest, Biggs said.  

“You have this disconnect where people have this strong moral feeling … yet they never paid enough to finance those benefits,” he said. “Other countries don’t have these problems in part because they don’t frame their Social Security programs quite the same way – they don’t emphasize the ‘earned benefit’ part.”  

The taxable wage base for the Federal Insurance Contributions Act, or FICA, has an earnings cap of $168,600 this year, Franklin noted. When the taxable nature of benefits was changed in 1983, the assumption was that the system could be funded as long as 90 percent of wages were taxed for Social Security, she said. However, as average income has increased, only about 83 percent of wages are taxed, and the income cap would need to be raised to about $250,000 to meet the 90 percent level the system once had, she said. And even that would cover only some of the system’s shortfalls.  

“So many people make so much more than the taxable wage base,” Franklin said. “You have this imbalance.”  

And even though lifespans are longer, the full retirement age is being increased by only two years, to 67.  

RAISE TAXES OR CUT BENEFITS?  

Any changes to the system will be unpopular, even if necessary. And whatever form that takes will require bipartisan support to pass, Biggs said.  

“I don’t think that either party, even if they have the presidency, the House, and the Senate, can reform Social Security on its own,” he said.   

Democrats tend to favor raising taxes, but fixing Social Security that way would require the largest single tax hike in history, he said, and most progressives might not favor such a big increase being used solely for Social Security.  

“Parties almost need to be rescued from themselves at this point,” Biggs said.  

Further dampening the political urgency is that the benefits of any action taken today won’t be realized until long after most incumbents are out of office.  

Among those vying for the Republican presidential nomination, Nikki Haley has campaigned on the promise of fixing Social Security. She hasn’t proposed details but has alluded to benefits cuts for people who currently are just starting to pay into the system.  

Meanwhile, Trump recently floated the idea of covering Social Security shortfalls with revenue from federal oil and gas leases. Such a plan would pay for less than 4 percent of Social Security’s gap, based on revenue from current oil and gas leases, according to an analysis by the Committee for a Responsible Federal Budget. Leasing all possible land available for oil and gas would also not cover the Social Security trusts’ shortfalls, that group concluded.  

“In this political environment, it doesn’t matter if it’s implausible,” Biggs said.  

GOVERNMENT INACTION  

If Congress does nothing, the benefits paid out will be cut to about 80 percent of the levels promised to people in 2014, Franklin said.   

“I guarantee no one is going to be satisfied with 80 percent of promised benefits, which is why we need lawmakers to step up and offer solutions,” she said. “The challenges are enormous, but this is probably one of the most important duties that our lawmakers have. People should be angry that they’re not addressing it.”  

A partial fix could include means testing, which would make the system benefit lower-income families more than wealthier ones who don’t rely on Social Security to make ends meet.  

“I personally think that is a bad reason, because part of the reason Social Security is so popular … is the fact that virtually everybody pays into it and everybody gets a benefit from it,” Franklin said.   

Raising the retirement age – as Haley and other Republicans have suggested – could also help, but only to a point, Biggs said. For example, raising the age to 69 would address only about a fifth of the system’s funding shortfall, he said.  

But adjusting the benefits so that Social Security does more for lower-income retirees could be necessary, he said. A couple retiring today at 67 who earned mid-level wages could get more than $56,000 combined annually in benefits payments, which is more than double the $22,000 elderly poverty threshold, he said.   

 And the maximum annual Social Security benefit of $45,000 is too high, as those who receive it simply don’t need it, Biggs said. 

“Every developed country has basically the same issues we have” with aging populations, he said. “The other programs tend to pay more generous benefits on the lower end. It’s a stronger safety net than [US] Social Security … There’s just no purpose of having to pay some rich guy $45,000 a year.”  

If no changes are made to fix the system ahead of the 2030s, we should expect a big tax increase and debt financing, which has limits, Biggs noted.  

PLANNING FOR UNCERTAINTY  

Many Gen X clients don’t want to rely on Social Security, and some aren’t counting on benefits in the future, said Marguerita Cheng, CEO of Blue Ocean Global Wealth.  

As part of her data-gathering process for financial planning, she encourages clients to start online Social Security accounts so that they can see their exact benefits, she said.  

“I approach these conversations with sensitivity because I know the political environment can be so polarizing. The conclusion is that I tell clients Social Security isn’t simply a monthly check. It’s a valuable income stream. The decision to claim is not just financial, but also personal,” Cheng said in an email. “While we don’t know the specific details of how [Social Security] will change, financial planning can help us be better prepared.”