Shoring Up Social Security

For years, policymakers—and future beneficiaries—have been wringing their hands over the prospects for Social Security. And make no mistake: The program is headed for trouble.

According to projections that the Social Security Board of Trustees released last April, starting in 2021 the program’s annual costs will exceed its income from employee and employer payroll taxes and interest earnings. Once the program turns that corner, Social Security will begin drawing down assets in its trust funds to continue providing full benefits. Largely driving the shortfall is a decreased birth rate since the baby boom generation, creating a higher ratio of retirees to workers paying into the program.

Social Security’s trust funds are on course for depletion in 2034, according to estimates the trustees issued in November to gauge the effects of the coronavirus crisis. That’s a year earlier than the 2035 depletion date the trustees had predicted in a report issued in April. Job losses, reduced hours and slowed wage growth diminish the amount of payroll tax revenues coming into the program.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

The stakes are high. Overall, Social Security benefits represent about 33% of income among those 65 and older, according to the Social Security Administration. Half of married couples and 70% of single people rely on Social Security benefits for 50% or more of their income. And 21% of married couples and about 45% of unmarried people receive at least 90% of their income from Social Security.

After the trust funds run dry, Social Security could pay out about 75% to 80% of promised benefits with incoming payroll taxes. For many of those who expect to be in or near retirement by the mid 2030s, the prospect of a smaller Social Security check is alarming.

But lawmakers are almost certain to buttress the system before that happens. An extended benefits cut is “unthinkable for so many older Americans who rely on the program,” says Shai Akabas, director of economic policy for the Bipartisan Policy Center, a Washington, D.C., think tank. In all likelihood, any changes to the program will preserve full benefits for retirees who are already receiving them or will soon start collecting them. Younger generations, however, may not receive the same level of benefits provided to current retirees.

The fixes

Policy experts have floated plenty of proposals to keep Social Security solvent. And the Social Security Administration itself offers a lengthy summary of potential changes, including details on how much each alteration would reduce or increase the shortfall over 75 years. “It’s not a very complicated program—it’s money coming in and money going out,” says Alicia Munnell, director of the Center for Retirement Research at Boston College. “You just need people with the political will to put together a package that would solve the problem.”

Essentially, there are two approaches, says Munnell: Add revenue to keep benefits at their current level, or cut benefits to match the level of revenue coming in. Or, to look at it another way, the options are to change benefits that are paid out and change taxes that fund the program’s benefits, says Akabas. “Almost any realistic solution at this point, given where the program’s finances are today, will need to include some of each of those categories,” he says. Here are some of the most prominent reform proposals.

Boost the payroll tax rate. Currently, employees pay a Social Security tax of 6.2%, and employers also pay 6.2% of the employee’s salary, for a total 12.4%. (Self-employed workers pay both the employee and employer share.) In its own calculations, Social Security offers several scenarios, including one that raises the total payroll tax by 0.1 percentage point per year between 2026 and 2045, until it reaches 14.4%. That would reduce the shortfall by 46% over 75 years.

Legislation proposed by Democrats in Congress would gradually raise the total tax rate by 0.1 point per year over 24 years so that employers and employees would eventually each pay 7.4%, for a total of 14.8%. In a 2016 package of recommendations, the Bipartisan Policy Center suggested a more modest increase over a shorter time, raising the tax to 6.7% each for employers and employees—a total of 13.4%—over the course of 10 years.

Increase the limit on wages subject to tax. Each year, Social Security sets a limit on how much of each worker’s wages are taxed, based on average increases in wages. For 2021, the cap is $142,800.

“I think raising the payroll tax cap is a popular idea,” says Maya MacGuineas, president of the Committee for a Responsible Federal Budget. One option is to adjust the limit to a higher level, then base future annual increases on a modified index. President Biden supports a plan that would maintain the current structure for the taxable maximum but reapply the 12.4% tax for wages above $400,000; the amount of earnings between the initial maximum and the $400,000 threshold would not be taxed. Because the maximum rises over time, all wages would eventually be taxed. Workers who owe tax on earnings higher than $400,000 would not receive increased benefits despite the extra tax payments.

Expand the types of income taxed. The program could pull tax from other sources besides wages, such as investment income or employer and employee premiums for employer-sponsored health insurance. By Social Security’s reckoning, adding a 6.2% tax to investment income for high earners starting in 2022 would reduce the shortfall by 30% over 75 years.

Raise the full retirement age. As the system stands now, Social Security’s full retirement age—the age at which a recipient is eligible for full benefits—is 66 for those born between 1943 and 1954 and gradually rises to 67 for those born in 1960 or later. Those who claim before their FRA (as early as age 62) receive a reduced monthly check; delaying your claim past your FRA, up to age 70, increases your benefit.

There’s precedent for raising the FRA for those who still have decades of work ahead of them. In 1983, Congress approved amendments to the program that gradually increased the FRA from 65 for those born in 1938 or later. One idea is to index the FRA to longevity—an approach other countries have taken, says Olivia Mitchell, executive director of the Pension Research Council at the University of Pennsylvania’s Wharton School.

The Bipartisan Policy Center suggests that starting in 2022—the year that the first beneficiaries with a full retirement age of 67 turn 62—we should increase the FRA and the age for receiving maximum benefits by one month every two years, continuing for 48 years. In 2070, the FRA would be 69 for those starting to claim Social Security, and the age to receive maximum benefits would be 72; the age of earliest claiming eligibility would remain at 62. Social Security estimates that this method would reduce the shortfall by 18% over 75 years.

Alter the formula for cost of living adjustments. Each year, Social Security calculates a cost of living adjustment (COLA) for benefit checks based on the consumer price index for urban wage earners and clerical workers (CPI-W). In 2021, checks are increasing by 1.3%.

Arguing that the CPI-W overstates inflation, some proposals call for linking COLAs to a “chained” CPI, which accounts for changes in consumer spending patterns as prices increase; if beef prices rise, for ex­ample, consumers tend to sub in lower-priced meats. Generally, chained CPI rises less over time than the CPI-W. Social Security estimates that switching to the chained index would shrink the annual COLA by an average 0.3 percentage point and reduce the program’s shortfall by 19% over 75 years.

President Biden, however, wants to give COLAs a lift by pegging them to the consumer price index for the elderly (CPI-E), which puts more emphasis on expenses that tend to be highest for those 62 or older, such as health care. Social Security estimates that switching to the CPI-E would increase annual COLAs by an average 0.2 percentage point, and it would cause a 13% increase in Social Secu­rity’s shortfall over 75 years. (For other reforms that would increase the shortfall, see below.)

Adjust the benefits formula. Social Security calculates the amount a ben­eficiary is due at his or her full retirement age by averaging the worker’s highest earnings over 35 years, adjusted for wage growth, and ap­plying a formula. Workers who had low earnings receive a benefit that replaces a higher percentage of their average preretirement income than those who had high earnings. Some suggest changing the formula so that the replacement rate is the same or higher for low earners but smaller for high earners, who more likely can rely on other income sources in retirement.

What you can do

If you’ll be nearing retirement or already retired when reforms are adopted, you probably won’t have to worry about cuts to your benefits. “I wouldn’t think they’d touch the basic benefit for people who are retired, and I don’t think they’d touch it for people who are 55 and older,” says Munnell. If you can afford it, we recommend holding off until at least your full retirement age—and ideally until age 70—to claim benefits, rather than applying early out of concerns that no money will be left for you if you wait. Claiming at 62 instead of your FRA lowers your monthly check by up to 30%. Postponing your claim until age 70 boosts your benefit by 8% for each year you wait past your FRA.

Working longer—even if only part-time in later years—is one way to lessen your need to claim benefits early and delay tapping your own retirement savings, helping to ensure a greater income stream when you do retire. And younger generations would be wise to plan on working well into their sixties, given the possibility that Social Security may shift to a later full retirement age—not to mention the headwinds impeding their own savings, such as high student debt.

And the longstanding advice to save early and often for retirement rings as true as ever. Thanks to compounding returns, you’ll benefit from an early start even if you set aside only a small amount at first. Although Social Security isn’t going to evaporate, some financial planners who work with younger clients advise them to save as though it won’t be there or to assume a cut of up to one-fourth to one-third of their expected benefits.

When will reform happen?

The sooner Congress acts to shore up Social Security, the more time it will have to spread out tax increases or benefit changes, potentially easing the burden on younger generations who will shoulder most of the load. “This is a problem that policymakers have known about for decades, but it has been much easier to kick the can down the road than to make difficult and generally unpopular decisions,” says Akabas. The last time Congress passed major Social Security reforms, in 1983, the program’s trust funds were just three months from running out of money.

Plus, the government has more-pressing issues at hand as it grapples with the effects of the coronavirus pandemic. And the trust fund that pays for Medicare Part A will run dry in 2024—much sooner than Social Security’s expected depletion date of 2034—according to predictions from the Congressional Budget Office. “I don’t foresee Social Security being a top issue on the agenda for the incoming presidential administration,” says Akabas.

One issue likely to get bipartisan support soon: Boosting benefits for people born in 1960, who turned 60 last year. To determine benefits, Social Security averages a worker’s 35 years of highest earnings and adjusts them for average growth in wages until the year the worker turns 60. Because the recent economic downturn caused a significant decline in average wages, people born in 1960 are facing a permanent benefit cut of about 5%, says Munnell. “I don’t think anybody will let that happen,” she adds.

Expand benefits?

Some proposals would improve benefits for vulnerable groups, which would worsen Social Security’s deficit. To strengthen the program’s finances, policymakers would have to offset such moves with measures such as the ones above.

For those who spent at least 30 years working, President Biden wants to establish a minimum benefit of 125% of the poverty level. He also supports increasing benefits for surviving spouses. Currently, when one spouse dies, the other receives 100% of the highest benefit available to either of them. For a couple who had similar lifetime earnings, household benefits can drop by as much as half when a spouse dies. Biden would raise the monthly payout for widows and widowers by about 20%. And, to protect aging beneficiaries at risk of outliving their savings, Biden would provide higher monthly checks to those who have been receiving benefits for at least 20 years.