I care about our young people, and I wish them great success, because they are our hope for the future, and some day, when my generation retires, they will have to pay us trillions of dollars in social security.
— Dave Barry, America Writer and Humorist
Social Security began in 1935 and has evolved into a program that covers 98% of all workers and that pays benefits to one in six Americans. In 1940, when monthly benefits began, recipients numbered 222,000; today, more than 47 million people receive benefits. 35% of those over 65 rely solely on Social Security payments; one in three workers has no retirement savings other than Social Security; and 50% of Americans have $2,000 or less saved for retirement, according to Dallas Salisbury, president of the Alliance for Investor Education
This year, and for the first time in 25 years, Social Security is projected to take in less in taxes than it is spending on benefits: high unemployment and low wage inflation result in diminished payroll taxes; and older unemployed workers are opting to begin Social Security earlier. Is Social Security approaching insolvency? Can the baby boomers count on receiving their benefits? A recent USA Today/Gallup poll found that 60% of workers do not believe they will ever receive Social Security payments, and that 56% of workers and retirees thought that their Social Security benefits will eventually be cut.
In August, the 2010 OASDI Trustee Report was issued, taking a 75-year outlook on the financial stability of Social Security. During 2009, the Social Security trust fund increased to $2.54 trillion, a net increase of $122 billion (includes $118 billion of interest and $22 billion in income taxes that higher income retirees pay on their Social Security benefits). Some argue that the $118 billion in interest is not a legitimate source of income, as it is just the government borrowing from itself. Indeed, the $2.54 trillion trust is nothing more than an IOU from the government. What's going to happen when those IOU's are needed to begin paying benefits as the costs start to exceed all revenues sources, a scenario currently projected for 2025? Stephen C. Goss, chief actuary of the Social Security Administration, answers that the government will refinance the debt. In other words, it will sell new Treasuries to the public and use the proceeds to pay back the Social Security trust fund. The Treasuries held by the trust fund are guaranteed as to the principle and interest by the full faith and credit of the U.S. government, as are all publicly held Treasuries.
The Social Security's actuarial projected deficit is often confused with the U.S. budget deficit, but the fact is that the redemption of Treasury securities by the trust fund will not affect the U.S. government budget deficit. The Social Security trust fund is a stand-alone system, self-financed and prohibited by law from borrowing. Unlike the U.S. Treasury, the Social Security trust fund cannot run a deficit. Using, a rolling 75-year view of the trust fund and identifying problems earlier so that we can make adjustments as we go could help keep the trust fund solvent. If not, beginning 2025, the trust fund principle will be needed to make payments. By 2037, the trust fund is projected to be exhausted and the system will return to a pay-as-you-go system.
In their annual report, the Trustees outline the mathematical changes needed to bring the system into balance over the next 75 years. The projections are done based on high, intermediate and low-cost scenario. The latest projections under the intermediate-cost scenario would require either an increase in payroll taxes by 1.84% or a 12% reduction in benefits. Obviously, the longer we wait to fix the system, the more expensive it will get.
The solutions being discussed focus on increasing payroll taxes and the eligibility age for full benefits. President Obama has appointed a bipartisan deficit commission that is likely to address Social Security reform sometime after the midterm elections. For more information on options being discussed, you can view these reports:
- Congressional Budget Office: Social Security Policy Options
- American Academy of Actuaries: Social Security Reform: Possible Changes in the Benefit Formulas and Taxation
- AARP Public Policy Institute: Reform Options for Social Security
In considering the potential solutions, I believe it is important to understand the cause of the underfunding, which is a lower ratio of workers to retirees. In the 1950's there were 16 workers contributing to Social Security for each retiree receiving benefits. Today, there are 3.3 workers for each retiree; by 2025, there are projected to be just two workers for each retiree. One obvious solution not being discussed much is to increase the number of workers. The U.S. is in a unique position in the world to be able to attract workers from other countries through immigration. We can even do it selectively, by making it easier for foreign students who graduate from our universities to receive work visas and even become citizens. There is much talk about closing our borders and not enough on making it easier to enter the U.S. legally, so that those immigrating become taxpayers as well! A more open legal immigration policy might even have the added benefit of reducing illegals.
As the solutions are being debated, what do we do about our own retirement? Clearly, we cannot wait for the government to solve our problems. Americans are responding by increasing savings as the Commerce Department reports a national personal savings rate of 5.8% (August, 2010) while just three years ago, the personal savings rate was 1.7%. While I do believe that Social Security will continue to pay benefits for many generations, I also know that Social Security is not enough. We must each take personal responsibility to plan for our future.
If you are still working, the first best course is to contribute the maximum you can to a retirement plan through your employer. If there is no retirement plan where you work, start your own IRA (before-tax contributions) or Roth IRA (after-tax contributions). Earmark part of every raise to saving and don’t forget to build up your after-tax savings as well.
If you are nearing retirement, it's especially important to get help. Keep in mind that most people will see their net worth double or triple in the five-year period up to retirement. Understanding the different payment options within the Social Security program will help you to maximize the benefits you are entitled to receive.
If you are retired, and particularly if you retired recently, it's likely that you have many years ahead of you, so it is very important that your savings not retire when you do. And, don't overlook options you may still have to change the way you receive your Social Security. If your income and savings are still not enough, it's important to find out sooner rather than later, as a small decrease in spending now may help avoid drastic reductions later. If your savings are more than enough, then planning will help you minimize estate taxes and maximize what you are able to pass on to your heirs.
How much do you need to save? The answer depends on many individual factors: lifestyle, age, health and longevity. There is no one rule of thumb so I encourage you to seek the advice of a Certified Financial Planner to help you come up with a plan tailored to you.
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