Social security is in trouble. It begins hemorrhaging red ink this year, paying out more in benefits than it takes in from taxes, and will continue to do so for the foreseeable future. These projected deficits will overwhelm the social security trust fund, and once that runs out, the government may be forced to slash benefits.
Could the government finally address social security’s chronic underfunding? Lawmakers in DC recently introduced legislation that would extend social security’s solvency until 2100. However, owing to bi-partisan bickering and conflicting agendas, passing the legislation will prove difficult, if not impossible. Still, it’s worth looking at the proposed reforms and what they could mean for social security and financial planning.
Anyone planning for retirement, however, should assume that no major reforms will pass and that social security benefits could be slashed by 21 percent or more as soon as 2034. This means you have to save and invest enough to ensure your financial security.
Social Security’s Solvency Problem
We mentioned in a prior blog post that social security is projected in 2019 to begin paying out more each year in benefits than it takes in through payroll taxes – generating an annual deficit for the first time since the recession-impacted years of 1975-1981. To fund these annual deficits, the SS administration must dip into the social security trust fund to make up the difference.
Unfortunately, these deficits not only will continue but they’ll get larger each year. Reasons for steadily rising deficits include increasing life expectancies, the ever-increasing number of retiring baby boomers and the declining ratio of the number of people working (and paying social security taxes) to the number of people receiving benefits.
If Congress does nothing, funding these rising annual deficits will deplete the $2.9 trillion trust fund by 2034, forcing a 21% cut in benefits. Any cut would be especially bad news for the roughly 33% of all recipients whose benefits comprise more than 90% of their income.
In response to looming benefit cuts, lawmakers are looking into reforming social security and ensuring that it remains solvent.
Social Security 2100 Act
After many years of sticking their heads in the sand about social security’s pending insolvency, there’s finally some movement within the government. More than 200 Democratic lawmakers have agreed to support legislation that was recently reintroduced by Rep John Larson, D-Connecticut. If enacted as it currently is written, the Social Security 2100 Act would extend social security’s solvency for 75 years to about the year 2100. Key elements of the legislation include:
Institute a payroll tax on high earners. For 2019, social security only taxes earnings up to $132,900 – the employer pays 6.2% and the employee pays 6.2% for a total tax of 12.4%. The new legislation would institute the same payroll tax on earnings above $400,000, temporarily leaving no social security tax on earnings between $132,900 and $400,000. Since the tax cutoff of $132,900 rises each year at the rate of inflation, this earnings gap would eventually be closed.
Increase the payroll tax rate. The combined (employer and employee) social security payroll tax rate would gradually increase from 12.4% to 14.8% over the next 24 years, which equates to a .1% annual increase. Remember, since the employer and employee split this tax, the gradual increase equates to a .5% annual increase for each from 6.2% to 7.4%.
Increase the threshold of income to begin taxing social security. Currently, up to 50% of social security income is taxed if your “combined income” is greater than $32,000 and up to 85% of social security income is taxed if your combined income is greater than $44,000. These two thresholds have historically not been adjusted for inflation. The new legislation would raise these thresholds to $50,000 if single and $100,000 if married and tax up to 85% of social security income above those thresholds.
Change the PIA formula. Primary Insurance Amount (PIA) is the amount of social security received at full retirement age. The new legislation would change the formula that determines PIA. The estimated net impact would be an approximate 2%-3% increase in benefits.
Revise the annual COLA definition. Since about 1975, annual social security benefits have been increased at the rate of growth of the CPI-Urban (Consumer Price Index for Urban Wage Earners). This index is based on the spending habits of workers, which underweights key spending categories (like healthcare) for people over 62. Underweighting these important spending categories results in an understatement of inflation, and thus, shortchanges recipients’ annual increase in benefits. The new legislation will use the CPI-Elderly, which more closely reflects the spending habits of those retirees. (Refer to our post on Stealth Inflation).
Set a minimum distribution. The current minimum social security benefit falls below the poverty line. The new legislation would increase the minimum amount to approximately 125% of the poverty line.
Retirees Can’t Count on Reform, However
Social Security’s underfunding must be addressed. To be blunt, it should have been addressed years ago. Better late than never, however. The above plan is compelling. It would solve the immediate funding issues and since changes are gradual, neither employers nor employees will feel much pain.
Unfortunately, the Social Security 2100 act may already be dead in the water. While many Democrats are pushing for gradual changes that would largely preserve social security as is, many Republicans have been advocating for more drastic reform, including privatization. The wide gap in policy vision makes it unlikely that any type of reform will be accomplished in the near future.
Meanwhile, Congress is occupied with ongoing budget issues, the border wall, North Korea, sanctions on Iran, the trade war, and more. And with the 2020 Presidential Race fast approaching, many politicians have elections on their mind. Don’t be surprised if social security is a major 2020 election issue.
However, if an overhaul of social security was pushed through before the election, that would certainly be a major surprise. Anyone planning for retirement shouldn’t count on it. And if social security reform does occur in the near future, it’ll likely be incremental.
For now, those planning for retirement should spend more time planning and should ensure that they are saving enough to enjoy financial security. Everyone should factor in the possibility that social security benefits could eventually be cut. Fortunately, you can use the Relax Retirement Planner to plan for retirement, which will allow you to enter different social security payouts and other assumptions.