The Social Security Debate
Today the only sure thing about social security is that the rhetoric will rage on. Cut through the fray with this introduction to the issues and workings of this 70-year-old retirement program.
By Kimberly Lankford, Contributing Editor, Kiplinger's Personal Finance
March 17, 2005
Advertisement
Okay, everyone -- Republicans, Democrats and economists -- agrees something must be done to keep social security in the black. But don't expect a fix this year. The country simply isn't ready for it.
Eventually, someone must touch the third rail, or the entire social security train will come to a screeching halt. The politicians say everything is on the table, which means there will be lots of alternatives to debate. And debate at this stage is healthy. It will test public reaction to major changes and legislative resolve.
To help you cut through the fray, here is a nonpartisan introduction to the 70-year-old retirement benefit. Social security also pays disability and survivor benefits, but because the debate has focused on present and future retirees, so will we.
- What's the problem?
- Trust Fund Troubles
- Private Accounts: A Separate Issue
- How much you're taxed
- How much you'll get
- When you'll get it
- Retire early, get less
- What if you keep working?
- Social security timeline
What's the problem?
It basically boils down to, at some point (the most commonly used estimate is 2018), the social security system will be paying out more in benefits than it will be taking in through payroll taxes. When that happens, money spent on other government programs will have to be used to pay obligations to the nation's retirees.
Social security is not a deposit account, it is not a savings plan; it is a pay-as-you-go insurance plan. The money collected as social security taxes pays current benefits, not your own benefits in the future.
The government currently collects more in payroll taxes than it pays out in benefits -- more on that in a minute. However, the population of retirees will grow faster than the population of contributing workers:
- In 1950, there were about 16 covered workers for each social security beneficiary.
- There are currently 3.3 workers for each beneficiary.
- By 2042, there are expected to be 2 workers for each beneficiary.
Despite the system's complexities, there are only a few moving parts that can affect its solvency: The amount of taxes collected, the amount of benefits distributed and the length of time retirees will collect those benefits (by altering the retirement age).
Trust fund troubles
More money is collected in social security taxes than is currently spent in benefits. The extra money goes into the social security trust fund ... and is quickly replaced with a special IOU from the U.S. Treasury.
By law, the excess money collected from social security taxes must be invested in special securities issued by the Treasury. The government then spends the cash on other programs or pays down the national debt. In 2004, the social security surplus was $153 billion.
When social security's cash flow turns negative in 2018, the trust fund will need to be tapped. Administrators will start cashing in those IOUs so they can write benefits checks.
At that point not only would Congress lose its social security cusion, but it would also face even more difficult choices as it repays the trust fund: raising taxes year after year, cutting spending in other areas, or borrowing even more money (affecting interest rates and the stability of the dollar abroad).
And, if the system doesn't change, the trust fund would spend through all its IOUs by 2042.
Private accounts: a separate issue
President Bush recently returned from a cross-country campaign stumping for so-called private accounts, an option for workers younger than 55 to voluntarily divert some of the social security taxes they already pay (up to the first 4%) to accounts that could be invested in the private sector.
Bush has offered few details on his plan, but one thing is certain: Private accounts do not resolve social security's solvency issues.
If anything they would take more tax money out of the system.
And workers who opt in to private accounts would also be volunteering for a reduced guaranteed social security benefit.
The Bush Administration concedes these points, but says the increased gains from stock market investments would make up for the benefits reductions.
Critics of private accounts also point to their start-up costs: an estimated $2 trillion that would be financed through additional borrowing.
How much you're taxed
Everyone who pays social security taxes earns credits toward future benefits. In 2005, employees pay 6.2% in social security taxes on up to $90,000 of their income. Employers kick in another 6.2%. That first $90,000 is what's referred to as "the income cap" and has risen over the years to adjust for inflation.
If you're self-employed, you must pay both the employee's and employer's share yourself -- bringing your social security tax rate up to 12.4%.
Employees pay another 1.45% of their entire salary in medicare taxes; self-employed people pay 2.9%
How much you'll get
Your benefit amount is based on your income during your 35 highest-earning years, indexed for inflation. If you retire before working 35 years, then the calculation includes a $0 for each missing year.
You should get an earnings statement from the Social Security Administration each year showing the income they have on record for each year you've worked so far and an estimate of what you might receive at retirement if your income remains steady until then. These numbers will change if you get raises in the future, but it gives you an idea of where you stand.
If you haven't received an earnings statement, you can order one online or by calling 800-772-1213.
Run your numbers through one of the Social Security Administration's benefits calculators to estimate what might happen to your benefits if your income changes through the years.
You'll get the most accurate information if you use the detailed calculator, especially if you plug in numbers from your earnings statement.
The quick calculator can give you a general idea of what to expect without taking up much time (it estimates your benefits based on your current earnings, rather than asking for the specific numbers from your social security statement).
A 40-year-old earning $70,000 per year, for example, can expect to receive about $1,852 per month in today's dollars when he reaches full retirement age, which will be 67 for him (the calculator also give you the option to adjust the results for inflation).
The average payout amount for retired workers currently receiving benefits is $955.
When you'll get yours
You may have noticed that the figures above were based on a full retirement age of 67, not 65. That's because people born in or after 1938 have to wait a little longer to claim their benefits. Here's how it breaks down:
| ||||||||||||||||||||||||||||||
For more information about the full retirement age, see the full retirement age calculator at the Social Security Web site.
Retire early, get less
You can also choose to receive benefits earlier or later if you want.
You can choose to receive benefits as early as age 62, but your monthly benefit amount will forever be about 20% less than if you waited until full retirement age to start getting the checks. In theory, you would receive the same amount of social security benefits over your lifetime. Because you are dipping into the pot sooner, your payments would have to be smaller to last the rest of your life.
That 40-year-old man earning $70,000 per year, for example, would only receive $1,282 per month if he started taking payments at age 62. This man would have to live until age 78 in order for the higher checks from the full retirement benefits to make up for the lower checks he started getting at age 62.
You can also choose to delay taking social security benefits until age 70, which will increase your monthly benefit.
That 40 year old would receive $2,314 per month if he waited until age 70. But he'll miss several years worth of checks, and would have to live to be 82 in order for the higher payouts to make up for the years he wasn't receiving benefits.
It rarely makes sense to delay taking benefits beyond your normal retirement age unless your family has a history of living for a very long time.
The benefits calculator also shows the break-even points for various retirement ages.
What if you keep working?
This calculator, however, doesn't show what happens to your benefits if you continue to work.
If you're still working and take benefits before your full retirement age, your payout amount will be reduced by $1 for every $2 you earn above $12,000 in 2005.
The rules are a bit more complicated for the year you reach full retirement age. In that year, social security deducts $1 in benefits for every $3 you earn above $31,800 -- but the cap in that year only applies to money earned before the month you reach full retirement age.
Because of these limitations, it's best to delay taking social security until at least full retirement age if you plan to continue working. There is no earnings limit after you reach full retirement age.
These earnings limits only apply to wages and self-employment income; investment earnings, pension payments and IRA withdrawals don't count.
Social security timeline
The system has already changed quite a bit since it was first introduced 70 years ago.
1935 - Congress enacted the Social Security Act, which became effective in 1937. The Old-Age and Survivors Insurance program started by providing retirement benefits to workers age 65 and older.
1939 - The program was expanded to cover dependents and survivors of covered workers.
1956 - The program expanded to provide income for to disabled workers.
1966 - Medicare was created, providing health insurance to most Americans age 65 and older.
1975 - Social security began giving annual cost of living adjustments based on changes in the consumer price index. Before then, benefits were only increased when Congress passed special legislation. Benefits had not been increased at all during the first 10 years of the program.
1977 - Amendments were made to help prevent a social security funding shortfall (the 1975 Social Security Trustees Report had predicted that the Trust Fund would run out of money by 1979). The amendments increased the payroll tax for social security plus medicare from 6.45% to the current 7.65% and slightly reduced benefits.
1983 - Social security was adjusted again to deal with funding problems. Several changes were made, such as approving the taxation of social security benefits for people above certain income levels and raising the full retirement age (the retirement age increases didn't affect beneficiaries until 20 years later).
2000 - Repeal of the retirement earnings test. Social security beneficiaries no longer lose any benefits for continuing to work beyond full retirement age (although their payments will be reduced until full retirement age if they take early benefits and continue to work).
2004 - 30 million retired workers receive an average monthly retirement benefit of $955; maximum monthly benefit is $1,939 for workers retiring at full retirement age.
2018 - Social security is expected to pay more in benefits than it collects in taxes and will have to start tapping the trust fund.
2042 - The trust fund will run out of money if nothing changes. At that point, social security taxes for the year would support only about 73% of the expected benefits.