Unless you're close to retirement age, whether you can count on Social Security benefits to help fund your retirement is a concern.
Currently, the system collects far more in Social Security taxes than it pays out in benefits, but that will change drastically as growing numbers of baby boomers retire. At the end of 2003, the Social Security system had excess assets of $1.5 trillion, invested in special-issue Treasury bonds. Starting in 2018, the system will start paying out more in benefits than it collects in taxes, so it will have to start using interest and principal from its bond investments. Those assets are expected to be totally depleted by 2042. At that point, unless changes are made to the system, benefits need to be reduced by 27% to equal revenues collected (Source: Social Security Administration, 2004).
When the Social Security system's excess funds are invested in Treasury bonds, the federal government takes the proceeds and spends it on current budget items. Thus, there is concern about where the government will get the money when the Social Security system starts to cash in these bonds. Since the government doesn't have excess cash, it will have to increase taxes, reduce other expenditures, or issue more debt. How easily the government will be able to do that is of considerable debate, especially since growing deficits are becoming a major concern.
There are three main factors causing this substantial shift in the finances of the Social Security system:
- Large numbers of baby boomers are about to retire.
Currently, 47 million people receive Social Security benefits. Starting in 2008, 77 million baby boomers will be retiring over an 18-year period (Source: The Wall Street Journal, June 28, 2004).
- Workers paying for these benefits will drop proportionally.
Many people mistakenly believe that all their contributions over the years are accumulated in an account in their name and benefits are paid from that account when they retire. However, Social Security is a "pay-as-you-go" system, meaning current workers pay the benefits for current retirees. In 1950, 16 workers were paying for each retiree's benefits. Currently, there are 3.3 workers supporting each retiree, which will drop to only 2 workers for each retiree in 40 years (Source: Social Security Administration, 2004).
- Life expectancies are increasing.
When Social Security started in 1935, the life expectancy of a 65-year-old was 12.5 years. That figure is now 17.5 years, meaning payment of an additional five years of benefits, and is expected to continue to increase in the future (Source: The Wall Street Journal, June 28, 2004).
The convergence of these three trends will place a tremendous burden on the Social Security system. Some of the more common alternatives suggested to reform the Social Security system include:
- Increase Social Security taxes.
The Social Security Administration estimates that the expected shortfall over the next 75 years could be eliminated if payroll rates were immediately increased by 15%. In addition to raising overall Social Security tax rates, that could involve increasing the maximum wage used for assessing Social Security taxes. Another alternative is to assess income taxes on a greater portion of Social Security benefits. Currently, recipients with income in excess of certain limits can have up to 85% of their benefits taxed. The income limits may be lowered or the maximum percentage of benefits taxed increased.
- Reduce benefits.
The Social Security Administration also estimates that the expected shortfall over the next 75 years could be eliminated if benefits were reduced immediately by 13%. Other options could include reducing benefits for higher-income retirees or reducing annual cost-of-living increases.
- Raise retirement ages.
While the retirement age is scheduled to gradually increase from age 65 to age 67 by 2027, an even higher age may be used based on increasing life expectancies. In addition, the early retirement age of 62 could be raised or abolished.
- Privatize all or part of the system.
Various alternatives have been presented, ranging from setting aside a limited percentage of Social Security taxes in individual accounts to fully privatizing the system to allowing the government to invest some or all of the tax receipts in stocks and bonds. President Bush strongly supports personal accounts, but has made little progress in accomplishing that goal.
Will the Social Security system provide benefits for the baby boomers? Yes, it is a system so ingrained in our culture that it would be very difficult to eliminate. Will those benefits be as generous as they are now? Probably not, since drastic changes will be needed to keep the system viable in the future. While dealing with the problem now would allow the changes to occur gradually over a number of years, many doubt that Congress will have the foresight to deal with this politically unpopular problem before it becomes absolutely necessary to do so. Thus, personal savings will become an even more important component of retirement income.