Social Security Isn't 'Going Away'

I wrote a response to the recent Twitter outrage over a MarketWatch article that advised workers to have 2 times their salary saved by age 35. 

To show readers how they could achieve that goal, I computed the per-paycheck 401(k) deduction that would help you save twice your salary by age 35 and determined that a savings rate of 15% of your pretax salary would give you a good chance of getting there.  

To my surprise, readers took issue not with my advice to save 15% of your pretax salary (which I concede is a huge effort) but with my assertion that Social Security will also provide some income during retirement years. The majority of the feedback I received was from self-identified millennials, who told me that I was flat-out wrong to say that Social Security would still exist--in any form--come 2050 or so when they retire. They insisted that Social Security would be bankrupt, and they would never see a dime. 

Indeed, according to the results of a Gallup poll conducted in 2015, nearly two thirds of all workers between the ages of 18 and 29 didn't believe the Social Security system would be able to pay them any benefit when they retire. 

It surprised me to learn how pervasive this belief is, because it's false.

'Social Security's Trust Funds Will Be Exhausted by 2034'
This oft-repeated statement is likely the source of confusion. While the statement is true, it's not the death knell of the entitlement program.

The interest received from invested trust fund assets is a smaller source of Social Security funding. The main source--more than 85% in 2017--is the Federal Insurance Contributions Act tax on workers' earnings, and presumably, payroll taxes aren't going anywhere. 

A percentage of your salary is withheld to pay the FICA tax--currently 12.4%. You pay 6.2% and your employer pays 6.2%, up to a maximum of $128,400 in 2018. You and your employer also split a 2.9% Medicare tax. (If you're self-employed, you pay both halves.) On top of that, employers or self-employed individuals are responsible for withholding the 0.9% Additional Medicare Tax on an individual's wages paid in excess of $200,000 in a calendar year, regardless of filing status. (There is no employer match for Additional Medicare Tax.)

"A lot of times you'll hear 'Social Security bankrupt in 2034,'" said Andrew Salata, a public affairs specialist with the Social Security Administration. "[But] bankruptcy is not the complete picture because Social Security after 2034 will still have payroll tax dollars. We will have used up our trust fund, our extra money that we've been collecting.

"So if nothing changes between now and 2034, we still will be able to pay out Social Security benefits, but it will be at a rate of 79% because that's what our payroll tax dollars will cover. So in effect everyone will receive 79% of their benefit." 

What Are the Trust Funds?
The Social Security Administration describes Social Security as a "pay-as-you-go program", where most of the payroll taxes collected from today's workers are used to pay benefits to today's recipients.

It would work out great if the tax revenues exactly equaled the benefits being paid out, but it doesn't. Some years, the money coming in to Social Security exceeds the program's payment obligations, and the excess money is credited to the trust funds. 

The Old-Age and Survivors Insurance and the Disability Insurance trust funds are separate entities but are often referred to collectively as OASDI. The trusts serve as a way to track the accounting--payroll taxes collected, benefits paid out, and administrative expenses paid. If the taxes collected exceed the amount paid out, the excess is credited to the trust funds and invested in interest-bearing U.S. Treasury special issue securities. 

If the amount paid out in benefits is greater than the amount collected (as is projected to be the case this year), the Social Security Administration will make up the shortfall by dipping into the trust funds.

The costs of the Social Security program are projected to increase to the point that they will regularly exceed the tax income collected. The shortfall will be covered by net redemption of the trust fund assets; currently the OASDI trust funds are over $2.8 trillion, according to the Social Security Administration. There are only sufficient excess funds for the next few decades, though. If no steps are taken to bridge the gap between taxes collected and rising costs of benefits, Social Security's board of trustees projects that the combined trust funds will be exhausted in 2034. After that point, continuing tax revenue is expected to be sufficient to cover around three fourths of the expected benefits. 

Plan on Three-Fourths Then?
The "Social Security's trust funds are going bankrupt" rallying cry was never meant to be interpreted to mean that the program would eventually cease to exist. Rather, it was a call to action by Social Security's board of trustees that there would be a significant drop in the level of benefits that would be payable if no legislative action were taken to rectify the financing shortfall between now and 2034. 

Morningstar contributor Mark Miller believes it's unlikely that no action will be taken, however. He and others believe there are plenty of levers available to Congress. Rather than cut benefits radically, Congress is more likely to impose some sort of means-testing on benefits, adjust the amount of income that's subject to Social Security, or increase full retirement ages. 

This sort of action is not without precedent. In 1983, Congress took action to address a coming intergenerational inequity. It raised payroll taxes and cut benefits in order to build up a reserve to support benefit payments for the large wave of baby boomers who would start retiring around 2010. For nearly three decades, taxes collected exceeded the amount paid out in benefits, and the surplus was invested interest-bearing special issue Treasuries.

Factor It Into Your Savings
If you hadn't been including Social Security in your long-term financial plan, you should factor it in, keeping in mind the possibility of a reduced benefit.

Also--and this may be an obvious point--don't confuse three-quarters of the expected benefit payment with 75% of your total monthly income needs. Social Security was never intended to be the only source of income for people when they retire. Rather, Social Security replaces a percentage of your preretirement income based on your lifetime earnings. This percentage is higher or lower depending on how much you earn and how old you are when you file for benefits. If you wait until full retirement age, Social Security can replace up to 75% of income for very low earners, about 40% for medium earners, and about 27% for high earners. Every year you delay claiming benefits (until age 70), these percentages increase.

A good rule of thumb: Aim to replace 80% of your preretirement income from a combination of investments, savings, and Social Security.