A reoccurring topic that has come up in conversation with clients is the certainty of Social Security benefits in retirement. Between the growing Federal deficit, inflation, and unstable political environment, Americans are worried about what the future holds. For tens of millions of people, Social Security retirement benefits is anywhere from supplemental retirement income to the safety net that they need to survive when they are no longer able to work. What we know so far is what has been done in the past to mitigate major benefit cuts, and what is being talked about now.
Basics of the Social Security Retirement Benefit
The potential for decreases in future benefits is a particularly sore topic for many Americans who have been paying into the system for their entire working lives. This is done through Payroll taxes. Between you and your employer, 12.4% is paid into the Social Security system. 6.2% is paid by you, and the other 6.2% is paid by your employer. If you are self-employed, you bear the brunt of the entire amount. Thankfully, this is not on an unlimited amount of income. The amount of your income that is subject to the Social Security Payroll Tax tops out at $160,200 for 2023, but this amount increases annually. This is what is known as the Social Security Taxable Wage Base. Any income beyond that amount does not pay into the Payroll tax.
After working and paying into the system for 10 years, you are considered permanently insured with a right to benefits when you retire. Retirement benefits can currently be claimed between the ages of 62 and 70 with Full Retirement Age (FRA) being between 66 and 67, depending on when you were born. If you take benefits before your FRA, your monthly amount decreases, and vice versa up to age 70.
Historical Changes in the Social Security System
Potential cuts to retirement benefits are nothing new. Underfunding concerns within the system go as far back as the early 1970s and since then it has been a key topic in a majority of presidential races. Since its inception in 1935 and up until 1972, retirement income benefits only increased when Congress enacted special legislation. In 1972, however, new legislation proposed the Annual Cost of Living Adjustments (COLA) provision that took effect in 1975. These COLA provisions created automatic, annual increases to benefits based on the annual increase in consumer prices. Accordingly, retirement benefits now get annual raises that match that year’s inflation rate. To alleviate the increased distributions from the Social Security Fund as a result of the application of COLAs, the same legislation in 1972 provided for automatic increases in the amount of earnings subject to Social Security taxes.
The most recent major reform was in 1983 when President Reagan ushered in the idea taxable benefits. With those changes, up to 85% of your benefit is taxable depending on how much total income you make while claiming benefits. Since then, multiple pushes for reform and several, less effective, laws were signed into force. None of which had the impact of the changes enacted in the 1970s and 1980s.
Basics and history aside, what is the likelihood of it being available in the future?
What is Happening Now
Every major reform in the past was preceded by “unforeseen” variables that pushed for major change, so what is the driving factor now, and what is being done to solve it? Between the Congressional Budget Office and the Social Security Administration itself, retirement income benefits are projected to hit the underfunded mark between 2033 and 2035 if nothing is done. Believe it or not, the Administration has been putting this information right in your statement the whole time. Prior to updating the look of the statements in 2021, you could find a bolded portion of text below your benefit section on page two outlining the expected decrease in benefits to roughly 80 cents on the dollar by 2035. That figure has changed by a few points over the years with current statements showing a 78% payout rate. As of 2021, that section is no longer directly on your statement. Newer statements have a small link at the bottom of the first page ironically reading ssa.gov/ThereForMe which takes you to a page dedicated to showing the projections for future decreases in benefits.
Among several variables that can put long-term stress on the system, two stand out: the retiring Baby Boomer generation and declining birth rates. The Boomer generation is one of the largest generations in history, followed by Generation X, Generation Y (Millennials), and Generation Z. The Millennial generation is the only one to match the size of the Boomer generation. Apart from those two, we have seen a slight decline in birth rates that are leading to smaller generations in comparison. When this all combines, we find ourselves in a supply and demand issue for benefits. The Boomer generation goes from paying into the system during their working phase to pulling from the system during their retirement phase. The assumption would be for future generations to sustain the supply of tax revenue needed to support the previous generations’ retirement, but that does not seem to be the case now. As it stands, the three following generations will not be able to sustain the taxes required to completely fund the system.
Current Efforts to Shore Up Social Security
With the 2024 Presidential race already starting to rear its head, we are seeing the topic of Social Security benefits become prevalent again. President Biden along with several other notable figures are proposing solutions to our current squeeze on the system. During his State of the Union speech in February, President Biden made Social Security a key topic with the intent to bring Democrats and Republicans together to ensure no cuts would be made. Although motivational, this has not resulted in any material changes yet. The most notable proposals include delaying the full retirement age yet again, raising the amount of income subject to payroll taxes, and reapplying payroll taxes beyond the current taxable wage base for high-income earners. Various other proposals that you may see in the coming race pose more creative solutions. One idea that has been floating around is to create a sovereign wealth fund that allows the Trust Funds to be invested in stocks. Another idea mentioned by former Vice President Mike Pence in a recent speech is to create a private savings account structure where individuals could take a portion of their Social Security withholdings and put them into a personal account, invested for their future retirement.
At this point in time, major policy reform is unlikely. The only progress we have seen is the current proposal called the TRUST Act (Time to Rescue United States’ Trusts) that would create a small, bipartisan commission dedicated to researching and creating solutions for federal Trusts Funds, the primary focus being on Social Security benefits.
Like most things in life, you should be looking ahead with a plan that you are confident in. Talking with your financial planner about scenarios with, without, and a reduced rate of Social Security benefits will show you how the unknown future of the benefit could affect you.
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