The annual report from the trustees of the Social Security and Medicare Trust Funds was a bit like “Groundhog Day.” Back in the year 2000, the trustees forewarned that an impending surge in retirements among Baby Boomers would cause the retirement and disability trust to run out of money by 2037 unless significant changes were made to shore up funding. Every year since, the overseers of America’s largest social program have issued increasingly urgent warnings as time has passed. Fast forward to 2022: Same tune, different verse. The latest analysis projects that the Social Security trust will be emptied by 2035, just 13 years away.
Barring Congressional intervention, current law dictates that once the trust is depleted, retirees’ monthly income payments will be automatically reduced by about 20% and slowly decline thereafter. In an independent analysis, the Congressional Budget Office estimates the tank runs dry by 2033, two years earlier. And if that’s not enough, the trustees expect the Medicare trust to be exhausted by 2028. While it is unimaginable that Congress allows the ship to run aground, every year that passes without action makes the fix incrementally more painful and costly.
President Franklin D. Roosevelt signed the Social Security Act in 1935, intending to provide supplemental income to retirees without adequate savings. By 1941, there were 41 active workers contributing to the program for every retiree, and early beneficiaries obviously received substantially more in payments than they paid in. Over the intervening years, the program has been significantly expanded to include disability and survivor benefits and in 1975 income payments were automatically indexed for inflation. In addition, the average life expectancy of beneficiaries has increased by about six years, while the qualifying age for full benefits has only increased by fewer than three years and the minimum age remains 62. At the time of the 2000 trustees report, there were only 3.4 workers supporting the program per retiree. Today there are just 2.7 workers per beneficiary, expected to decline to 2.3 by the time the fund is emptied in 2035.
There are many misconceptions about Social Security, the most prevalent being the notion that retired workers are receiving a return for their historical contributions. In fact, current Social Security income payments are financed by current workers’ payroll taxes, a structure known as “pay as you go.” The establishment of the trust funds for Social Security and Medicare have contributed to the impression that beneficiaries receive back what they paid in. In fact, the trusts are simply a reservoir into which payroll tax revenues stream and from which payments flow. If outflows exceed inflows as is currently the case, the reservoir eventually runs dry.
Those critical programs are financed by taxes on earned income. Technically, Social Security is comprised of two separate elements: Old Age and Survivors Insurance benefits, and Disability Insurance, each of which are separate deductions on your pay stub. Workers pay a combined 6.2% in Social Security taxes, matched by their employer for a total of 12.4% of payroll, capped at annual income of $147,000 in income. Medicare takes another 1.45% from each side for a total of 15.3% tax rate on income.
Tax revenue for Social Security, Disability and Medicare flow into three separate trust funds. The cash balance in the trust funds is invested in U.S. government securities with the income also accruing to the trust. All payments to beneficiaries including monthly retirement checks are paid out of the trust funds and by current law cannot come from general revenue of the treasury. That means once the trusts are exhausted, only current tax revenue from active workers can be paid out in benefits, expected to cover only 80% of expenses by 2035.
The fixes are not complicated, but by virtue of inaction by Congress for the past 22 years, the pain will be greater. Contrary to some familiar arguments, the fundamental issue is primarily a revenue shortfall and not a spending problem, as legislators have simply not responded to entirely foreseeable demographic inevitabilities. The 2000 trustees’ report noted the urgent need to anticipate the impending surge in beneficiaries between 2010 and 2030 forecasted to deplete the trust funds as the Boomers rode off into the sunset. If ever there was an entirely predictable and avoidable crisis, this was it.
Chris Hopkins in a chartered financial analyst and co-founder of Apogee Wealth Partners LLC.