Posted by: drdata921 | January 17, 2014


Social Security is in trouble and must be fixed. Estimates are that revenues from Social Security payroll taxes will be able to payout full benefits until around 2023. After that, the Social Security trust fund will need to make up shortfalls. What is the Social Security Trust Fund? Well, when people pay into Social Security, a portion of those revenues go to benefits for current retirees. What is left is put into the trust fund. Think of the trust fund as an IOU that can be redeemed to fund benefits when Social Security revenues fall short of what is needed. In reality, this money does not exist. It was put into general governmental revenues and has long since been spent. To redeem these IOUs, the government will need to borrow. Current projections are that the trust fund will last until 2033 at which time Social Security taxes will be able to cover only 77% of promised benefits.

The Stats

How important is Social Security. In 2010, 36 million people relied on it for retirement income. On average Social Security benefits cover about 38% of total retiree income. However, about 35% of recipients rely on Social Security for 90% or more. By the year 2030, a full 25% of the population will be over 65 years of age. This dependency will increase dramatically as the wave of Baby Boomers retires. It is obvious that fixing Social Security should be a priority in Washington although serious discussions by the Congress and the White House have not yet begun in earnest. The political and social implications of not fixing the problem could be dire.

The Potential Solutions

Obviously something must be done, but what? There are a number of possible solutions that could close a portion of the funding gap. Each of these solutions has strong proponents as well as others who are adamantly against the proposed changes. Here is a list of potential actions that could be taken. Some work on controlling benefits while some are focused on increasing revenues. On the revenue side:

1. Raise the Social Security Tax Rate: In 1937, when the program began Social Security taxes were 2% on incomes up to a certain amount. This has risen over the years. In 1987, during the most recent overhaul, the rate was increased to 12.4%. Half is paid by workers and half by employers. Current estimates are that if the individual rate were increased gradually from 6.2% to 7.2%, we could eliminate over half of the shortfall. If the rate for both individuals and employers increased to 7.6% the entire shortfall could be erased.

2. Lift the Payroll Tax Cap: Social Security taxes are only collected on incomes up to a certain amount. In 2014, once your income has gone over $117,000, you stop paying the tax. Estimates are that if this cap were gradually removed, about 71% of the Social Security shortfall could be eliminated. At present, less than 10% of workers have incomes that would be affected.

3. Means Test Social Security Benefits: Everyone who has paid into the system and meets some minimum criteria qualifies for benefits. Means testing Social Security benefits requires that if your non-Social Security income goes above a certain level, Social Security benefits are either reduced or eliminated. Current recommendations are to reduce benefits for people with non-Social Security income above $55,000 and eliminate them altogether when income is greater than $110,000. When I read this, I wondered whether these income levels would be inflation adjusted annually. This is important because withdrawals from 401K and IRA savings are counted as income and as inflation increases you need to draw out more from savings. These limitations could put an increasing number of retirees in jeopardy each year if not adjusted?

On the benefits side of the equation:

1. Raise the retirement age: People are living longer than in the 1930’s when the program was launched. The original retirement age was 65 years. In the 1940’s, for people who made it to age 21 only 54% of males and 61% of females also survived to the age of 65. In other words, a large number of people paid into the system, but never collected benefits. In 2009, the survival rate had risen to 82% of males and 89% of females. In 1940 once you turned 65, you had an expected lifespan of an addition 12.7 years for males and 14.7 years for females. At 65 in 2009, this had risen to 17.5 years for males and 20.2 years for females. More people are living long enough to collect Social Security and once they do, they collect for longer. In response to this, commissions that have studied this issue have recommended gradually raising the retirement age to 70 by 2050. This would cover about 21% of the shortfall by reducing the period the average retiree would collect benefits.

2. Reduce Annual Adjustments for Inflation: Each year, Social Security benefits are increased by the rate of inflation. Currently this is based on the Consumer Price Index (CPI) for urban workers. One recommendation is to lower the annual increase by adopting what is called the Chained CPI. If you want more information on this, see my blog entry [Will the Promises Be Kept – Social Security, April 2013 Archives]. The net is an estimated annual reduction in the inflation adjustment of 0.25%. If the normal CPI would increase benefits by 3% for example, the chained CPI would increase it by only 2.75%. While this seems like a small change the impact can be substantial over time. This option could cover about 20% of the shortfall.

So, as you can see, there are a lot of proposals, although little action up until now. Clearly something has to be done to fix Social Security. However, there are three questions that need to be considered as we move to a solution: 1) What set of options actually will solve the problem, 2) from the perspective of what you pay in and what you get in return are the solutions fair and equitable, and 3) are you giving retirees and near retirees enough time to adjust to any changes that will affect their income and standard-of-living. After all, this is both a financial and a human problem. In the move to a solution, let’s not forget that.


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