People may wonder, “Will I still get my Social Security benefits?” and the answer depends on solvency. In simple terms, solvency determines whether the Social Security trust funds have enough money to pay out all the benefits owed according to the current law.
Let’s think about how Social Security is formed. It’s based on two main funds: the one for retirement and survivors’ benefits (Old-Age and Survivors Insurance, or OASI), and the one for disability benefits (Disability Insurance, or DI). They work distinctly because these trust funds can only pay benefits if there is actual money in the accounts. Unlike other government fields, these are not allowed to borrow money to still pay the benefits if they run out of funds.
Basically, this means that our retirement money depends entirely on the payroll taxes collected for these trust funds and their ability to keep making payments.
According to past reports, the combined funds are projected to peak soon, but they will gradually decline and could be completely drained by 2037 if nothing changes. This doesn’t mean that Social Security will entirely disappear, but it’s going to be an inability to cover the full benefits.
There are different potential outcomes based on different assumptions. The most optimistic outlook talks about the fact that Social Security could remain solvent for the next 75 years, and the pessimistic version shows that trust funds could even run out of funds before 2037. Such projections highlight the uncertainty surrounding Social Security’s long-term future, which is a big issue in today’s economy.
The breakdown is clear: whether or not you’ll get full benefits depends on how the funds are managed from now on.
Why are the trust funds projected to run out of money?
The cost of the programs might exceed the money coming from taxes, meaning that the trust funds will need to raise the reserves more and more.
A Trustees Report on Social Security in 2009 predicted the problems Social Security started to face in 2016. That was when tax revenue alone was not able to cover the program’s annual cost anymore. This report showed the gap between taxes collected and the cost of providing benefits that were expected to grow over time.
Social Security’s $2.5 Trillion Buffer: Will It Be Enough to Avoid a Benefits Shortfall by 2037?
OASI and DI combined have built up over $2.5 trillion in assets. Even though the program will cost more than the collected taxes, the trust funds will use these assets to cover the gap for the moment. The problem comes when the reserves run out, which is projected around 2037. Tax revenue will only cover 76% of the scheduled benefits at that point unless changes are made. This is the major warning that has even been highlighted since 2009.
This is not the first time Social Security has faced challenges. Between 1973 and 1983, the trust funds had a negative cash flow, and the reserves were almost exhausted. With reforms in 1977 and 1983, things were turned around. The changes included adjusting how benefits were calculated, and the retirement age was raised from 65 to 67. Taxing Social Security benefits helped with the rebuilding to the current $2.5 trillion level.
Why Negative Cash Flow Doesn’t Always Spell Trouble for Social Security: The Importance of Early Planning
A negative cash flow in Social Security where tax revenue isn’t enough to cover the benefits is not necessarily the ticket to exhaustion. Actually, with a “pay-as-you-go (PAYGO) system, meaning the trust funds only keep one year’s worth of costs, this can involve a permanent negative cash flow.
This happens when the interest on the trust fund is higher than the cost growth rate of the program. In this case, it can be enough to keep the trust fund growing while also helping pay for the current benefits.
Based on current assumptions, the average real interest rate is expected to be 2.9%, and the program’s cost is assumed to grow by 1.6% annually starting from 2030 to 2080. With adjustments to maintain steady reserves, the interest could continue to support the payment of benefits alongside tax revenues.
A cash flow shortfall becomes a problem only if it’s long-lasting and large enough to drain the reserves over time. This is why they needed to implement major reforms before when the trust funds were close to running out. The OASI Trust Fund was almost unable to cover the benefits by 1983, and Congress needed to pass special legislation to be able to temporarily borrow money from other trust funds as they were working on new reforms to save the situation.
The changes to Social Security that took place in 1983 highlighted the importance of planning ahead, and thanks to reporting long-term projections from the trustees, the US was able to identify financing issues earlier than other countries, helping policymakers with time to develop solutions that address the needs of American citizens. This early warning system became essential in keeping Social Security on track.
With the warning provided by the trustee’s reports on Social Security, we have the chance to make the right changes to the program’s taxes or benefits long before they take effect. This gives people plenty of time to prepare and adjust to any upcoming change. It also makes it easier to introduce the changes gradually and avoid sudden jumps in taxes or benefits for future generations.
A gradual approach is, for example, the increase in the Normal Retirement Age (NRA) from 65 to 57, and that was part of the 1983 Social Security Amendments. This change that took place in 1983 only started to show effects in 2000, 17 years later. So, the full shift to a retirement age of 67 won’t be fully phased in until 2022. Long-term planning helps ease the impact of reforms and ensures people have time to adjust.
Two Trust Funds, Diverging Futures
As mentioned before, there are two distinct trust funds for Social Security—the Old-Age and Survivors Insurance and the other one for Disability Insurance. The first one was established in 1935, and it started to pay monthly in 1940. Disability benefits were introduced in 1956.
The DI program is believed to have a less favorable outlook compared to the OASI because, since 1983, costs for DI have increased significantly, in a significantly higher proportion than those for the OASI program.
However, benefits under the OASI program are also more predictable compared to the ones under the DI program. There is a higher uncertainty that surrounds the costs and financial status of the DI program. DI Trust Funds are immediately requesting special focus and action.
Future Changes for the Social Security Program
The change in the aged dependency ratio is the one that affects the ratio of beneficiaries to workers. There is a need for increased contributions per worker due to a similar worker base that supports the retirees, and this is a significant point of concern. Historically, there are 3.3 workers per beneficiary, and it’s projected to drop to two workers per beneficiary after 2030. At a single calculation, let’s think that now, for an average benefit of $1000 per month, each worker is now paying $300, while two workers would contribute $500.
To meet these costs, significant reforms are needed, and if action is delayed, benefits may need to be reduced by about 25% or payroll taxes increased by one-third.
Future reforms are likely to be a mix of benefit reductions and payroll tax increases, hopefully in a smooth manner.
Raising the normal retirement age may not be the primary solution to ensure long-term solvency. The challenges that Social Security is facing are also shared by Medicare and other retirement systems.
Globally, the decline in birth rates is a significant issue, and it’s particularly happening in Europe and Japan, as they face even steeper declines than the US. Various changes to the Social Security Act have been considered, with some options available for improving the OASDI solvency.
Addressing the challenges of Social Security comes with proactive reforms in order to ensure sustainability for future generations.
If you’re preparing for retirement, this is a guide that can help you maximize your benefits: Prepare for Social Security: The Insider’s Guide to Maximizing Your Retirement Benefits
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