Many times in life, we find ourselves riled up about a rumor we hear which may or may not be true. Rumors, not facts, raise our blood pressure and make us angry, fearful or worse. Headlines such as “Financial Outlook Dims For Social Security” and “Social Security Slipping Closer To Insolvency” may have this effect on you. After all, headlines are specifically designed to elicit an emotional response so the article will be read.
The latest trustee’s report estimates the Social Security OASDI Trust Fund will be “exhausted” by 2033.
Our motivation for this commentary is not with the articles or headlines per se. The latest trustee’s report estimates the Social Security OASDI Trust Fund will be “exhausted” by 2033. Make no mistake, exhaustion of the trust fund is a serious issue which needs to be addressed. What we wish to combat is much of the misinformation and misinterpretation about what this means for financial planning purposes.
In one press briefing, Michael Astrue of the Social Security Administration practically begged journalists not to scare the public about losing benefits. He explained, “Please, please remember that ‘exhaustion’ is an actuarial term of art and it does not mean there will be no money left to pay any benefits.”
Some in the press took Astrue’s admonishment to heart but others did not. Some simply declared the fund is running out of money and therefore no one should count on benefits. Talk radio and the talking heads on television piled on.
So what is going on with Social Security?
The state of the Social Security trust fund
What many failed to mention from the report was the Social Security Trust Fund had reserves of $2.7 trillion and took in $69 billion more than it spent the prior year from the taxes collected and interest on the bonds in the trust. Those bonds are sometimes described pejoratively as IOUs.
Well, all bonds could be called IOUs. The bonds in the trust fund are real. They are U.S. Government Securities, arguably the safest in the world. They pay interest to the trust that significantly exceeds what is available on the open market and are NOT subject to market risks because the bonds are always redeemed at face value. By law, trust funds cannot be used for any other purposes.
The projected exhaustion year seems to change every year. Back in 1994, it was 2029 and in 2003 the projection was for 2042.
How Social Security works
Perhaps an explanation of how Social Security works would help explain such differences. Social Security is funded through payroll taxes. These taxes are collected from wage earners and their employers and benefits are paid from these receipts. When more is taken in than is needed for benefit payments, the excess goes into the trust fund. There, it is invested in and earns interest from special issue Treasury bonds which are fully backed by the U.S. government.
By law, Social Security cannot borrow money. So when tax receipts plus interest are not enough to pay benefits, the trust fund will be tapped. The trust fund’s exhaustion comes about because as the baby boomer generation reaches retirement age, they leave the workforce. They stop adding to the system through payroll taxes and start drawing benefits. Thus, the number of workers and subsequent payroll taxes decline as the number of beneficiaries goes up.
It may seem like the shortfall would be huge to deplete $2.7 trillion in 18 years, but actually the long-range actuarial shortfall is projected to be just 2.88 percent of taxable payroll.
The latest projected exhaustion date is sooner than previous year’s projections because the weak economy cut taxable earnings while benefits were increased for inflation.
What if nothing is done to save Social Security?
So if Congress does nothing and the trust is exhausted, what happens to benefits? As Mr. Astrue explains, “After 2033, even if Congress does nothing, there will still be sufficient assets (from payroll taxes) to pay about 75 percent of benefits. That’s not acceptable, but it’s still a fact that there will still be substantial assets there.” Steve Goss, Astrue’s colleague and the chief actuary of the Social Security Administration added, “The choice is to either reduce benefits 25 percent, or raise revenues 33 percent to adapt.”
…it’s still a fact that there will still be substantial assets there.
This too added fuel to the press coverage and for good reason. According to the National Academy of Social Insurance, for half of married couples and two-thirds of singles over age 65, Social Security is their largest income source. A 25 percent cut would be huge for many recipients. Of course, a 33 percent tax increase on the payrolls of 2033 would be enormous too.
Can Social Security be saved?
One good thing to come out of the alarms is the fact that addressing the shortfalls sooner rather than later means any changes could be gradual and far less likely to be traumatic. Sooner means more time to plan. Some changes considered to help restore balance include: extending the start date for benefits by a year or two, a modest and gradual increase in payroll taxes over the next decade, and an increase in the cap on wages subject to payroll taxes ($118,500 in 2015).
A stronger economy means more jobs, higher wages, and thus more payroll taxes. If the economy continues to improve, do not be surprised if the projected exhaustion date becomes later than 2033.
We aren’t saying we can count on Social Security to remain as it is today, but we can say that even if Congress does nothing, we can count on Social Security to pay a significant portion of what it is supposed to.
We are headed into another Presidential election cycle and the potential for anxiety about Social Security is high and headed higher.
If Congress does act soon, it will mean fewer changes now rather than many changes later. The mathematics is not all that difficult, getting Congress to agree is clearly difficult.
Congress has acted many times in the past to shore up the system. In the late 70’s and early 80’s Social Security was running a deficit and the trust fund was projected to be exhausted in mid-1983. In April of that year, future benefits were reduced and taxes were increased. The cuts included raising the retirement age and changing the payout formula. The payroll tax rates were increased and applied to more wages while benefits became taxable and federal employees were added to the system.
The changes were not popular at the time and the process was greatly politicized. The rhetoric was just as vitriolic as it is today. Nonetheless, it was estimated at the time the changes would allow the trust fund to survive another 50 years. That would be 2033, exactly the same year today’s trustees project the fund will be depleted.
Don’t interpret this to mean we think Congress and the new president will fix things soon. We don’t. Better than trying to predict when we might see meaningful action instead of just hearing impassioned rhetoric is noting that the issue presents a significant amount of “noise” which is not helpful to sound financial planning and decision-making.
We are headed into another presidential election cycle and the potential for anxiety about Social Security is high and headed higher. Try to remember that while we have a real and significant problem on our hands, the problem is not insurmountable and even in the worst case all will not be lost.
If you have any questions or would like to discuss this further, please give us a call or send us a note.
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Moisand Fitzgerald Tamayo, LLC is an Orlando, FL and Melbourne, FL based fee-only financial planner serving central Florida and clients across the country. Moisand Fitzgerald Tamayo, LLC specializes in providing objective financial planning, retirement planning, and investment management to help clients build, manage, grow, and protect their assets through all phases of one’s life and the many transitions in between.
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