Social Security paid out more in retirement and disability benefits in 2018 than it took in via payroll (a.k.a. FICA) taxes. This has been the case each year since 2010 and is only projected to get worse. As a result, many people have become doubtful when it comes to predictions of Social Security’s solvency and long-term benefit payments. However, I tend to be more optimistic. My optimism stems from understanding the full range of options at Congress’s disposal for shoring up the Social Security trust fund in the coming decades. This blog post summarizes some of the options, many of which have already been formally proposed in Washington, but first a quick reality check…
If Congress does absolutely nothing (a likely outcome you might say!), the Social Security trust funds are projected to cover full payment of scheduled benefits on a timely basis until the fund reserves become depleted in 2035. At that time, the incoming payroll taxes (6.2% from employee and 6.2% from employer, up to a wage base limit of $132,900 in 2019) will cover 80% of the annual benefit payments to retirees, according to the 2019 OASDI Trustees Report. To put it more clearly, we face a looming 20% reduction in retiree benefits in the year 2035. Nobody is talking about benefits going to zero, at least not so long as workers continue paying into the system.
Having said all that, here are 11 ways Congress can alter Social Security to avoid falling off a “20% reduction cliff” in retirement benefits.
- Increase the full retirement age – Given that there is already precedent here, I think there’s a good chance Congress will do it again. In fact, the House Ways and Means Social Security Subcommittee has already put forth various proposals that would increase the full retirement age to 68-70.
- Increase the minimum age for benefits – Currently you must be at least 62 years old to begin receiving (reduced) Social Security retirement benefits. It is conceivable that this age limit could increase in tandem with an increase to the full retirement age.
- Increase the early retirement penalty – For those that do elect to receive benefits between age 62 and their full retirement age, the current penalty ranges between 5 – 6.67% per year permanent reduction in annual benefit.
- Decrease the benefit for delaying – Currently this benefit stands at 8% per year. The problem for most people is that they simply can’t afford to delay. So, this 8% benefit disproportionately ends up in the hands of very wealthy individuals. I think it likely that Congress decreases this benefit by 1-2 percentage points.
- Recalculate the annual cost-of-living-adjustment (COLA) – here’s another proposal already put forth by the House Ways and Means Social Security Subcommittee. Social Security’s current COLA is based on the consumer price index (CPI). Experts estimate that using a different measure for inflation, such as the “chained CPI,” which accounts for changes in consumer buying habits as prices change, would decrease the COLA by 0.3 percentage points.
- Tax up to 100% of Social Security benefits – currently up to 85% of benefits are taxable depending on income.
- Increase the wage base limit on which payroll taxes are collected – As noted above, Social Security payroll taxes are only levied on the first $132,900 of earned income. Raising this cap, or eliminating it entirely, would help to close most of the funding gap. Remember, Medicare payroll taxes have no wage base limit.
- Increase the payroll tax rate – As noted above, the payroll tax rate is 6.2% for employees and 6.2% for employers. Self-employed individuals pay both sides of the tax, or 12.4%.
- Alter the spousal and/or ex-spousal benefit – Spouse’s and any ex-spouse married at least 10 years can receive ½ of a retirees benefit amount. Congress could make dozens of potential tweaks here. For example, reduce spousal and/or ex-spousal benefit percent; increase number of years of marriage to qualify for ex-spousal benefit; split the total spousal and ex-spousal benefit across spouses.
- Tax all forms of salary reduction plans – Few people realize that salary reductions made directly into a flexible spending account (FSA) or a health savings account (HSA) are not subject to payroll tax. It would hurt the popularity of these plans to begin taxing contributions, but does it really make sense to impose payroll taxes on 401(k), 403(b) and other salary reduction plans and not on ALL salary reduction plans?
- Increase the number of years to qualify for benefits – Your Social Security paycheck is determined based on your highest 35 years of earnings, but if you didn’t work at least 10 years (technically 40 quarters) then you won’t qualify for any retirement benefit. Increasing this threshold would most likely hurt women disproportionately since they spend more time out of the workforce caring for children and other family members than men.
All the above are potential actions that could help to extend the longevity of the social security trust funds without having to directly reduce benefits across the board for all beneficiaries. From a purely political standpoint, reducing Social Security benefits would be difficult to say the least. Even in the unlikely event that Congress decides to directly reduce benefits, I think they would do so only for high-income earners. This could be done in several ways, such as based on the historical earnings history tied to a person’s Social Security record or by factoring in other retirement income sources like investments, pensions, and annuities (i.e., means-testing).
The Social Security Administration estimates that 21% of married couples and 44% of single seniors rely on Social Security for 90% or more of their income, so I think it’s fair to say that most retirees would like to avoid a 20% reduction in benefits. The good news is that Congress has many options at its disposal to ensure that Social Security continues to be a reliable retirement income source for the vast majority of Americans. Even better news is that there is precedent given the changes that have already been made to Social Security over the years to keep it solvent—increasing the age for full retirement benefits (1983); removing the benefits associated with the “file and suspend” strategy (2015); and phasing out the ability to do a “restricted spousal filing” (ongoing). I expect Congress to pull several of the levers listed above (most likely #1, 4, 6, 7, and 10) in a very gradual/phased approach (as they have in the past) so as not to disrupt the plans of the millions of Americans that are counting on their benefits to be there for them.