Many of you are familiar with the Social Security (SS) system, but for those who are not, it can be defined as follows: a federal insurance program that provides benefits (primarily income) to those that are retired or disabled. The system is funded through collection of Federal Insurance Contributions Act (FICA) revenues. FICA taxes are paid by both employers and employees – splitting the 12.4% total tax rate 50/50. (Note: an additional 2.9% is also split in this way to fund Medicare). These revenues accumulate at the US Treasury in a Trust Fund (known as the OASDI) until benefits are distributed.
As of month-end February 2022, just over 70 million Americans receive these benefits while more than 176 million Americans fund those benefits through the aforementioned tax structure. With that fact alone it sounds like a fairly reasonable and sustainable system, but is that really the case? The simple answer is that no.
Annually the Social Security Administration is bound to perform an actuarial analysis on the health of its programs and the sustainability of their assets. Key factors range from current revenues, to projected benefits for those not yet in the system, to population dynamics like birth and death rates. Unfortunately, the results have been increasingly foreboding over the last several decades. With each passing year, the estimated lifespan of the OASDI is reduced. In fact, the most recent analysis indicates that OASDI funds will be depleted between 2033 and 2035. Once those reserve funds are depleted, any benefits paid would need to flow directly from tax revenues. Presently, those revenues would only cover about 75% of benefits owed to eligible recipients. In short, if all else is held equal your current or expected benefit will be reduced by approximately one fourth of its originally calculated value in as few as 10 years.
So, what’s the solution? There isn’t a perfect one. Congress can not simply allow the system to lapse as far too many Americans are now dependent on the system and even more Americans are yet receive any return from their many years and even decades of contributions. In simplest terms, Congress has two options. Either raise revenues or reduce benefits. Actuarial estimates project that an increase of approximately 2% (split between employers and employees) of the present Social Security tax would cover the shortfall – alternately, benefits would need to be reduced as stated previously. Or, of course, some combination of both solutions.
As Congress is wont to do, they have not addressed this dilemma yet and will likely not until the eleventh hour. Proposed solutions will run the undoubtedly range broadly – from widespread slashing of benefits to demographically targeted tax hikes to fill the deficit. Quite frankly, it is impossible to predict how Congress will decide to maintain the program. What you should take from this, is to view your financial plan with an understanding that your benefits are not guaranteed. Either your projected benefits will be reduced or your ability to save will be diminished (through increased taxes). If you are concerned that your plan relies too heavily upon Social Security benefits, work with your advisor to stress test your plan with these potential changes.
