Personal Finance: Will 30-year-olds ever see a Social Security check?

Personal Finance: Will 30-year-olds ever see a Social Security check?

August 20th, 2014 Chris Hopkins in Business Diary

Chris Hopkins

Photo by Patrick Smith/Times Free Press.

Pew Research polled millennial generation adults to gauge their confidence in Social Security. The result was sobering: only 8 percent expect to get the currently promised benefits, while a staggering 51 percent expect to receive nothing at all.

Given the magnitude of unfunded liabilities, millennial skepticism is understandable. The shortfall in funding future benefit payments is indeed daunting, but not overwhelming, if changes are enacted now.

The three main federal social welfare programs, Social Security, Disability Insurance and Medicare, each operate out of separate trust funds. Payments to beneficiaries are funded by payroll tax revenues into the trusts, plus interest income on the funds invested (in U.S. Treasury bonds), and taxes collected from current recipients who work and pay tax on some benefits. The system has always operated under the pay-as-you-go principle, whereby taxes from current workers cover benefits to retirees.

Since the last major reform in 1983, the trust funds took in more money than they have paid out, until 2011 when outflows exceeded inflows. Under present conditions, the trust fund for Social Security will be depleted in 2033. At that point, benefits will be reduced by one fourth unless Congress intervenes.

(The Disability Insurance trust is slated to go broke in 2016 and awaits urgent action by Congress and the President. However, this program is smaller than Social Security and likely to receive a temporary bailout while the larger issues are addressed).

Fortunately, the impending crisis in Social Security is fairly easily addressed with a modest blend of tax increases and benefit adjustments phased in over the next 30 to 40 years.

Social Security taxes are currently collected on the first $117,000 in wage income, covering roughly 82 percent of all wages. Raising the bar to tax 90 percent by the year 2050 will erase about a third of the shortfall. Requiring that all newly hired state and local government employees join the system by 2020 would add 4 million new taxpayers and increase reserves.

Stronger means testing of benefits for high income recipients is generally supported by both political parties. Making the benefit schedule more progressive could shave another third off of the deficit by reducing payouts to wealthier retirees.

Average life expectancies have increased by six years since 1935, but the retirement age has risen by just two years. Indexing the retirement age to longevity over the next 40 years will cure another one fifth of the shortfall. Most proposals include an exception for earlier retirements due to health considerations.

Meanwhile, economists have long agreed that the Consumer Price Index used to figure cost of living increases in benefits overstates the rate of inflation. Adopting a more accurate measure (so-called chained-CPI) will have a small incremental impact on individual retirees but a measurable effect on the solvency of the trust over time.

While not completely painless, these measures are gradual enough to find broad acceptance once understood and taken together provide for the program's solvency until 2085.

The concept of privatized subaccounts within Social Security is not yet widely supported, but the idea has merit and could be rolled out for experimentation at a later date once the fundamental program is stabilized. Separate accounts invested in stock index funds or bonds could accelerate the rate of accumulation in the trust funds and increase the retirement income of future beneficiaries.

There is general agreement on many of these adjustments; differences exist primarily in the relative mix. But action now will assure a relatively modest impact on any one worker or retiree. Delay will guarantee that the pain increases exponentially.

Christopher A. Hopkins, CFA, is vice president at Barnett & Co. Investment Advisors.