For millions of retirees, Social Security provides an essential source of income in retirement. In 2020, around 50 million retired workers collected Social Security benefits, according to the Social Security administration.
However, the recent 2021 Social Security Trustees report finds that in 2034, retirees will start receiving a reduced benefit if Congress doesn’t fix funding issues for the social program. In other words, Social Security will exist after 2034, but retirees will only receive 78% of their full benefit starting then.
“No major Social Security legislation has been passed at all since the early 1980s,” says Alicia H. Munnell, Director of the Center of Retirement Research at Boston College. “And so we do have this event coming up that forces Congress either to do something, or most people’s benefits are going to be cut by [nearly] 25%.”
Select spoke with two experts about how Social Security works, why it faces a long-term funding issue and what Congress can do about it.
How is Social Security financed?
In order to understand why Social Security is facing a long-term financing issue, it’s important to know how Social Security works. First off, Social Security is funded through payroll tax deductions. These payroll taxes are taken directly out of an employee’s paycheck and are paid by both employees and employers. In 2022, payroll taxes apply to up to $147,000 of an individual’s annual income.
The payroll tax rate for Social Security is 6.2%. This means that employees pay 6.2% and employers pay 6.2%. Self-employed people will pay the entire payroll tax rate of 12.4%.
When a worker pays their Social Security payroll tax, that money doesn’t go to a specific Social Security fund allocated just for them. Current workers are paying into a system that pays for the benefits of all current retirees.
In 2022, for every dollar you pay in Social Security payroll tax, 85 cents goes towards the Social Security trust fund that pays monthly benefits to current retirees and their families (and surviving family members of workers who have died), according to the Social Security Administration. The other 15 cents goes to a trust fund that pays benefits to people with disabilities and their families
In recent years, there has been an excess of reserves in the Social Security Trust Fund: the amount of money that the Social Security administration collects through payroll taxes exceeds the amount of money the administration pays out in benefits.
“It’s all predicated on money going in from current workers to money going out to beneficiaries,” says Kathleen Romig, a Senior Policy Analyst at the Center on Budget and Policy Priorities. “You want to have the worker to beneficiary ratio at a sort of healthy level where you don’t have too few [working] people paying for too many beneficiaries.”
Over the next ten plus years, the Social Security administration will draw down its reserves as a decreasing number of workers will be paying for an increasing number of beneficiaries. This is due to a decline in the birth rate after the baby boom period that took place right after World War II, from 1946 to 1964.
“People are having fewer children and because the birth rate is declining you just have fewer workers paying for beneficiaries,” says Romig.
Starting in 2034, the Social Security administration will run out of the excess reserves it has and will only be able to pay out a portion of a retiree’s full benefits — 78% to be exact. This means that retirees could receive reduced monthly benefits or fewer checks each year, according to Romig — that is unless there is a policy change made by the U.S. government.
Why is Social Security important?
Social Security is vital to many retirees and is one of the few social programs that enjoys broad support across the political spectrum. A 2020 AARP survey found that the program was supported by 90% of Democrats, Republicans and independents.
While Social Security is intended to supplement peoples’ retirement savings, many retirees end up relying on the program’s benefits as their primary source of retirement income. According to the Center on Budget and Policy Priorities, half of seniors get half (or more) of their retirement income from Social Security.
The National Institute on Retirement Security (NIRS) describes retirement income as a ‘three-legged stool’, consisting of Social Security, a pension plan and individual retirement savings through accounts like a 401(k) or an individual retirement account (IRA).
With only half of private sector employees having a 401(k) at any time, Social Security is one of the most important aspects of retirement income’s ‘three-legged stool’, says Munnell.
“The 401(k) system has worked well for, let’s say the top 40% of workers and is not much help for the bottom 60%,” says Munnell. “A lot of our population has nothing else to rely on other than Social Security, so you really don’t want to have that benefit level cut.”
What can Congress do about Social Security’s funding issue?
Munnell notes that there are two ways for Congress to solve the current long-term funding issue. The Social Security administration can either cut benefits for people or increase tax revenue.
Cutting benefits could mean reducing benefits for everyone or increasing the full retirement age again. Congress could also pass legislation that would increase tax revenue for the Social Security administration by raising the payroll tax rate or by increasing the Social Security payroll tax income limit from $147,000.
The last time Social Security faced a reserve deficit was 1983. The solvency issue was resolved through bipartisan legislation that, among other changes, increased the full retirement age from 65 to 67 over time and charged income tax on Social Security benefits
Recently, House Democrats introduced the Social Security 2100 Act which would increase Social Security benefits for low-income workers, change the price index the cost-of-living-adjustment is tied to and reapply the payroll tax rate to individuals making more than $400,000.
Since legislation regarding Social Security cannot be passed through reconciliation (a procedure that allows the Senate to pass legislation with a simple majority of 51 votes), any legislation would require support from both Democrats and Republicans, says Romig.
“All we need is political will and that is something in scarce supply, even in the best of times. 2034 to a congressperson is a long time away… So there’s no incentive on the part of the people in Congress to solve this problem before it is imminent,” says Munnell.
How can you supplement your Social Security income?
When it comes to investing for retirement, it’s essential to start saving as early as possible whether that’s through an employer-sponsored 401(k) or pension plan or through an individual retirement account.
Though experts recommend saving between 10% and 15% of your annual income, you can start small and increase your savings rate over time, especially if you have outstanding debt from credit cards, healthcare expenses or student loans.
If you have an employer that matches your 401(k), maxing out your matching contributions should be your first priority as it’s essentially free money. Many employers will offer to match typically between 2% and 4% of an employee’s annual salary.
After you’ve maximized your employer match, you might consider opening an individual retirement account which is a retirement account separate from your employer. The traditional retirement account and Roth IRA are two types of popular retirement accounts.
Both retirement accounts offer different tax advantages. A Roth IRA is an after tax retirement account where individuals use income that’s already been taxed and their investments grow tax-free over time. This means you won’t have to pay taxes on your investment gains later in life.
A Roth IRA, however, has an income limit so it’s not available to everyone. For 2022, the income limit for individuals is $144,000 and for married couples filing jointly, it’s $204,000. Select found that Charles Schwab, Fidelity Investments, Ally Invest and Betterment offered some of the best Roth IRAs.
On the other hand, a traditional IRA is a pre-tax retirement account where individuals’ contributions are tax deductible now, but they’ll have to pay income taxes later when they withdraw money in retirement.
Depending on your annual income and whether you have a retirement plan through work, your traditional IRA contributions may also be considered tax deductible. In other words, your traditional IRA contributions could lower your income which could reduce the amount you owe in income taxes.
Select ranked Charles Schwab, Fidelity Investments, Vanguard and Betterment as the top companies offering traditional IRAs. Some of these brokerages offer robo-advisor services that will manage the money in your retirement account and build a portfolio for you based on your risk tolerance, time horizon and retirement date. Robo-advisors will rebalance your portfolio over time as you get closer to retirement. Some of the top robo-advisors include Wealthfront, Betterment and SoFi.
Bottom line
Current workers will still receive Social Security benefits after the trust fund’s reserves become depleted in 2034, but it’s possible that future retirees will only receive 78% of their full benefits unless Congress acts. To ensure that workers receive what they were promised, Congress must pass legislation to solve the Social Security administration’s long-term funding issue.
