Focusing on Social Security's Future

Is Social Security going bankrupt? Not exactly. Nevertheless, the program faces stiff challenges, requiring thoughtful reactions from retirees and pre-retirees as well as from the professionals who advise them. Spoiler alert: it is a matter of when, not if, Social Security runs out of money.

The latest (May 6, 2024) annual report from The Board of Trustees, Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds states that the Old-Age and Survivors Insurance (OASI) Trust Fund is on a glide path to financial peril: It will be able to pay 100% of scheduled benefits only until 2033. (The 2024 Medicare Board of Trustees' report (PDF) is slightly more upbeat, with reserves depletion projected in 2036.) As the trustees put it, "Both programs continue to face significant financing issues." To me, that is the understatement of the century.

The 79% Solution

Keep in mind that the OASI report does not mean Social Security will go out of business in 9 years, with payments of benefits closing down. Even without reserves, income from paycheck withholding, employer contributions and the self-employment tax would cover 79% of the monthly checks estimated to be written for retirement and survivor benefits in 2034 (up from 77% in last year's report). If the projections prove to be accurate and no steps are taken in the interim, a beneficiary expecting $2,000 a month from Social Security would drop to $1,580 — 79% of $2,000 — in monthly benefits.

A summary of the findings of the Social Security and Medicare trust funds reports on the current and projected financial status of the two programs (along with a link to the full reports) can be found at: ssa.gov/oact/trsum/index.html.

Rational Reasoning

How can consumers and their advisors plan for the future of Social Security? Having had this discussion with numerous clients over the last several years, I have reached some basic beliefs that I pass along:

First, I think there is zero chance that the federal government will allow current benefits to be reduced. This would be political suicide. Second, as with other political hot potatoes, I suspect the politicians will act when they are forced to act. Third, between now and 2033, Congress must come up with more tax revenue in order to pay 100% of the monthly OASI bill to Social Security beneficiaries. Finally, tax and benefit adjustments need to be made in the Social Security retirement program for younger workers and future recipients.

The obvious problem is that Social Security will need more cash by 2034 in order to cover the monthly bill. Program changes for younger workers and future recipients probably will not generate sufficient cash by then. Only increased taxes and/or reduced benefits will have a timely impact on the program's "significant financing issues."

The obvious problem is that Social Security will need more cash by 2034 in order to cover the monthly bill.

Current Cash

What changes might be made in order to generate the increased dollars needed to pay the monthly bill in 2034? Here are some possible revisions:

1. Increase the OASDI tax base.

Currently, employees pay 6.2% of wages into Social Security, up to $168,600 in 2024, while employers match those contributions. Special rules apply to Social Security contributions from self-employed workers. One approach would be to increase the rate for earners above certain income levels without increasing their retirement benefits: Make high-income workers pay more without getting more. Such a plan might call for Social Security taxation to resume at, say, $300,000 or $400,000 or $600,000 in annual wages.

2. Increase the OASDI tax rate for all covered income.

Instead of a 6.2% rate, go to 6.5% or 7% or some other number: Make everyone pay more without getting more.

For some historical context, keep in mind that the OASDI tax rate was increased multiple times in every decade from the 1950s through the 1980s. From 1960 to 2024, the OASDI tax rate was increased 15 times. However, the last time the OASDI tax rate was increased was in 1990; that increase was only 2.31%, from 6.060% to 6.200%. There seems to be a chance that this rate will be substantially higher, going forward.

3. Increase the labor force participation rate: Get more workers paying into Social Security.

4. Make 100% of Social Security benefits subject to federal income tax.

Today, no more than 85% of benefits are taxed, and many beneficiaries owe no federal income tax on what they receive from Social Security: Make everyone pay more.

Funding for the Future

In addition to cash-producing tax changes, other Social Security revisions could help with long-term finances. Possibilities include:

1. Delaying full retirement age (FRA).

The age for beneficiaries to receive unreduced retirement benefits could be adjusted to reflect current life expectancies. Life expectancy at birth (for males and females combined) was 60.9 years in 1935, when The Social Security Act was signed into law. The youngest age for retirement benefits was 65 when the program started, and the cynic in me notices that the average American did not live long enough to collect any Social Security retirement benefits. In fact, in 1935 only 7% of the U.S. population was age 65 or older.

By 2020, the combined life expectancy for males and females was 77.4, an increase of 16.5 years. Meanwhile, the age for full retirement benefits has gone from 65 to 67 — a mere 2-year increase.

Common sense would seem to imply that the age for unreduced retirement benefits should better reflect the increased life expectancies in the past 90 years. Delaying FRA would (a) move some Social Security benefit payments from sooner to later; and (b) keep more people in the workforce, still paying into Social Security.

Common sense would seem to imply that the age for unreduced retirement benefits should better reflect the increased life expectancies.

2. Delaying early retirement.

Just as FRA could be delayed, the earliest age for retirement benefits — now age 62 — could be postponed.

3. Changing the bend point formula for future workers.

Social Security retirement benefits are based on average career earnings. They are heavily front-loaded by the use of "bend points:" 90% to the first bend point ($1,174 a month in 2024), 32% to the next bend point ($7,078), and 15% on subsequent earnings. Future bend points could be adjusted with fewer 90% dollars and more 15% dollars. Such adjustments could be refined to impact all covered workers or only high-income workers.

4. Means testing benefits.

The annual income of Social Security beneficiaries could be reviewed to see if some high-income people get reduced benefits or no benefits at all. Such a makeover might not be popular, as it would convert Social Security into a hybrid wealth transfer program.

5. Cutting delayed retirement credits (DRCs).

Currently, waiting for Social Security after FRA earns an 8% lifelong bonus for every year of forgone benefits. An investor can not get a guaranteed 8% anywhere today, so why should Social Security pay such princely sums?

A cost-saving move might be adjusting the DRC factor to something based on a common bond yield. For instance, the 10-year Treasury pays about 4.5%, as of this writing.

Note that the suggestions mentioned all involve reduced Social Security benefits. Such changes probably wouldn't apply to current recipients but might impact individuals claiming Social Security benefits after passage of the cost-cutting legislation.

What is Congress is likely to do to address the trust fund financial problem? I suggest looking at what our legislators have done in the past. The short answer is raise taxes…preferably on "the rich." (Actually, taxes probably would be imposed on taxpayers with ample income, rather than on those who own valuable assets.)

One legislative proposal attracting attention calls for keeping the 6.2% OASDI tax rate on earnings up to $168,600 in 2024, with the income cap annually adjusted for inflation. Then, the 6.2% tax would re-appear for people earning $400,000 and up, with no ceiling. In my opinion, this proposal is a good indicator of the direction Washington's politicians eventually will take to close the gap between Social Security's current inflow and outgo projections.

Calculating the Choices

My conclusion is that Congress has six choices when it comes to save-Social Security legislation:

1. Increase payroll and/or income taxes on some or all workers.
2. Cut benefits to all existing recipients.
3. Cut benefits to all future recipients.
4. Cut benefits to current and/or future high-income recipients.
5. Delay benefits to future recipients.
6. Enact a combination of the above possibilities.

With all the uncertainty the above list delivers, what should people be doing now? I recommend stress testing plans for retirement income. Evaluate the possible income reduction and tax increase scenarios. That is, taxpayers and their advisors should make sure retirement plan designs have a built-in safety factor. Plan for the worst and hope for the best.

One retirement plan design to consider is a "bucket strategy." In a basic arrangement of this type, a retiree has three buckets: Emergency Fund Bucket, Income Bucket, and Growth Bucket.

Example: Jim has all of his retirement assets in the Income Bucket; he has a problem. He will have no Growth assets to potentially deal with future tax increases or benefit reductions. In addition to some Growth assets, Jim also should have sufficient savings in an Emergency bucket to tap if his current income sources (such as Social Security benefits) are reduced and/or his future taxes are increased.