Is Social Security actually secure? If not, what should be done to fix it and who bears the cost?

A review of recent headlines makes this a question worth asking. This year, we witnessed a debt-ceiling debate that threatened the integrity of the U.S. Treasury and the ongoing operation of the federal government. We saw mass protests in France against a government trying to make slight changes to an unsustainable pension system. Given the timing of these events, it seems appropriate to review where America’s federal pension program stands. 

A brief history of Social Security

Social Security was signed into law on August 14, 1935, with overwhelming support. The Social Security Administration (SSA) started collecting contributions in 1937 and, according to www.ssa.gov , the first monthly benefit was paid in 1940 to Ida Mae Fuller in the amount of $22.54. In 1935, the average life expectancy was 61.7 years, but the age required to collect benefits was 65.

Social Security is a “pay as you go” system. Current contributions into the program are used to fund current payments to retirees, with any excess remaining in the “trust fund.” When the SSA was established, the worker-to-retiree ratio was 160 workers per retiree, with additional benefits for spouses and dependents. That ratio dropped to 42 workers per retiree by 1945, and now stands at just 2.9 workers per retiree, according to mercatus.org.

When Social Security was conceived, it was intended to be a supplement to the retirement savings of the elderly, but it was mathematically designed so that many people would never live to collect it. Current life expectancy in the U.S. is 79 years old, according to the CDC, but benefits can be received as early as 62 years old. Benefits are now inflation-adjusted with automatic cost-of-living adjustments tied to an arguably inflated inflation index. Over the years, benefits have become richer but adjustments to funding have not kept up.

The insecurity of the program lies in the demographics of the country and the way it is funded. When there were many more workers than retirees, the program built a significant surplus. Now, payouts exceed contributions, and that fund balance is falling fast. Adjustments to Social Security have long been considered a “third rail” political issue, meaning any discussion of benefit cuts is an immediate end to political aspirations. But Social Security (in its current form) is a math problem, not a political one, and the laws of mathematics are not subject to popular opinion.

Social Security funding is a simple equation: Payments from workers – benefits to retirees = trust surplus (or deficit). We are currently running a deficit and depleting the surplus built when the Baby Boomers were younger. The current surplus is scheduled to run out in roughly 10 years. To fix this, one of two things (or a combination of both) must occur: Payments into the system must increase or benefits paid out must decrease. What does this look like?

Ways to increase payments into the program:

1. Increase the contribution percentage: Employees and employers currently contribute 6.2% of wages into the Social Security fund on the first $160,200 in wages. Raising the contribution percentage would increase funds into the system.
2. Increase the contribution limit: Currently, only the first $160,200 is taxed. This amount is increased for wage inflation, but a higher limit or an elimination of the limit would increase contributions. This number is indexed to inflation.
3. Improve demographics:  More workers per retiree improves the trust fund’s balance sheet. We could hope to have more children, but the current American reproduction rate is 1.8 children per woman (less than the replacement rate). The U.S. has a better worker/retiree ratio than Europe, Japan, and China, and we could bolster our immigration policy to attract more young, productive taxpayers into the system.

Ways to decrease payments out of the program:

1. Reduce benefits: This could take many forms – means testing, income limits, and tighter qualification standards. These are typically very unpopular and universally rejected by politicians.
2. Increase the retirement age: Increasing the retirement age delivers a benefit on both sides of the equation. It increases the number of workers paying into the system and reduces the number collecting benefits. This was part of the 1983 amendment that gradually increased the full retirement age from 65 to 67. Life expectancy in the U.S. increased four years between 1983 and 2019 (although it dropped 1.5 years in 2020 due to COVID) so this might be a possibility. However, France is learning just how difficult this solution can be to implement.

Alternative Solution:

Allow deficits: Perhaps the simplest and most likely solution is to allow Social Security to run a deficit. For years, the surplus in the Social Security trust fund has been used by the government to finance ongoing operations. Supporting a deficit from the general fund doesn’t seem unreasonable.

According to the Social Security Board of Trustees, the surplus in the trust fund will be depleted by 2034. So, what happens then? According to current law, Social Security will become a true “pay as you go” system, paying out only what is collected from payrolls. AARP estimates this would cover only roughly 80% of what has been promised. It should also be noted that similar payroll taxes pay for Medicare, a trust fund that is scheduled to run out in 2031 and will then be able to fund only 89% of scheduled benefits.

So where does that leave the future of Social Security? First, arguments that “Social Security won’t be there when I retire” are untrue. Even in the worst-case scenario, where no changes are made, contributions would support 80% of the payout obligations. But the math does not lie. Unless changes are made to the “pay-in/pay-out” equation, full benefits cannot be supported without substantial changes to the system. Where those changes occur, and who pays the bill, is where the math gets political.

Warren Hurt is Chief Investment Officer for F&M Trust.