Broker Check

Canopy Commentary - Social Security

May 30, 2024

It seems like every news cycle includes an article about how the Social Security trust fund is about to run out of money.  However, “about” is somewhat of a misnomer.  You may have seen headlines about the latest report from the Social Security Trustees, which projects that the trust fund will run out in 2035, one year later than previous estimates. 

It is important to understand that this does NOT mean that social security benefits will stop in 2035.  The program receives revenues from two sources: the money paid in by workers through their FICA contributions, and, when this is insufficient to pay the full benefits, from the trust fund to make up the difference.  Roughly 20% of Social Security payments, in aggregate, come out of the trust fund each year.  According to the report, if congress does not take action to shore up the system, the trustees estimate that benefits would need to be reduced by about 20% in 2035.

You can access the trustees report here, or watch a brief summary video here

It’s unlikely that Congress will ignore the problem until 2035.  A significant number of retired Americans rely on Social Security for most of their income, and they vote!  Also, we’ve been here before.  The social security trust fund was last projected to run out in 1983.  In 1982, bipartisan legislation was passed by congress, and signed by President Reagan, to shore up the trust fund and continue to pay full benefits.  This legislation is the reason that the full retirement age has increased from 65 to age 67.  Note that the change in benefits did not impact anyone who would retire in the next 25 years.

So, which of the many proposals will be acted upon to solve the problem?  One is to continue to raise the full retirement age from 67 to 68 immediately, and then bump it up progressively by two months each year thereafter.  That would fill 44% of the funding gap and represent a roughly 13% stealth reduction in benefits to future retirees.  A second, similar proposal would index the Social Security retirement age to rising lifespans, which would address 20-25% of the funding gap.  Another proposal would lower the annual inflation adjustments for retirement benefits by switching to a different (less generous) inflation measure, which would fill an estimated 23% of the gap.

There are several proposals to increase the cap on FICA payroll taxes.  One would raise the cap from $110,100 to $215,000 of personal income, which would fill roughly 35% of the funding gap.  Another proposal would subject all earnings to Social Security taxes, which would fill 86% of the funding gap, and would only impact about 6% of American taxpayers.  Alternatively, there’s a Congressional proposal to raise the 6.2% payroll tax rate to 7.2% and leave the cap where it is (indexed to inflation).  This would reduce the funding gap by 64%.

Yet another proposal would reduce benefits for the highest-earning 25% of Americans, but this would only address 7% of the funding gap.  Another would tax contributions to retirement plans such as 401(k) programs (filling an estimated 10% of the funding gap); yet another would bring all newly-hired state and local government workers (who currently have separate retirement arrangements) into the Social Security system, which would address 8% of the funding gap. 

Finally, several proposals would create a means test for receiving Social Security benefits, meaning that people who are receiving higher income in retirement would see their Social Security benefits reduced.  However, these proposals seem to be less popular, as most Americans feel entitled to receive benefits from a system they’ve paid into, and rightfully so. 

Look for Congress to consider these ideas in the next session, and a possible combination of two, three or four of them to reach the House and Senate floor.  The sooner they enact a fix, the less drastic it needs to be to close the gap.  However, like most everything that comes from Washington, the solution is likely to be whatever is most politically expedient, rather than what makes the most logical sense.