By Michael Kitces
With talks of spending cuts, debt ceilings, and the risk of US default floating everywhere, it seems more and more people are writing off their future Social Security benefits as a total loss. Yet the latest Social Security Trustees Report released just a few months ago paints a dramatically different picture; channeling the spirit of Mark Twain, the latest analysis of the program might best be summarized as “the reports of my death have been greatly exaggerated.”
The reason that Social Security benefits are not about to collapse into nothing anytime soon – or even in the next 75 years – is because the majority of benefits are paid directly from the taxes being applied to current workers. This is remarkably different from how you or I save for our own retirement, where we put money into an account and invest it for growth, so that we can spend it in the future. In the case of Social Security, most of the money isn’t invested and saved for the future – it’s transferred directly from current workers to current retirees.
However, sometimes the system gets a little unbalanced. For the past two decades, the system has actually been taxing current workers more than was needed to pay current retirees, so the excess has been held in a trust fund invested in government bonds. As baby boomers have aged through the workforce, though, the worker-to-retiree balance is shifting. Starting in 2010, Social Security began to pay out more than it was collecting in current taxes; in a few more years, it will begin to liquidate its government bond portfolio to generate the cash needed to pay benefits. By current projections, the savings will run out in 2037.
So what happens then? Social Security retirees can only receive as much money in benefits as the system collects in taxes on workers, which will be more than 75% of what’s needed. In other words, if your future Social Security benefits are supposed to be $1,000/month in 30 years, the program would only have money to pay a little over $750/month. But that’s a far cry from getting paid $0. And that’s only the cut if we do nothing to fix the system for the next 25 years.
Alternatively, if we actually do take steps to help get the system back on track sooner rather than later, the cuts wouldn’t have to be nearly that severe. And if we end out solving most or all of the problem by raising the Social Security tax rate, then we don’t need to adjust benefits at all, and the necessary cuts would literally be nothing. Or we may end out with some combination of the two to make the system solvent: for instance, one viable option is a 1% tax increase along with a benefits cut of a little over 10% (which could be implemented in many ways, such as an adjustment to the cost-of-living adjustment rate over a period of several years or even decades).
So the bottom line is that while some adjustment to the Social Security system may be coming – and unless we solve all of it with a tax increase, the solution could include some form of reduction in future benefits – the financial reality of the system means the most likely scenarios are very modest cuts of a few percent over time, and even the worst case scenario is “only” a benefit cut of about 25% that doesn’t hit for 25 years. Yes, I realize that may certainly sting a little, and push us to save a little bit more to help make up a personal shortfall… but remember, it still means the overwhelming majority of your benefits are not dead, at all; they’re looking just fine.
Michael Kitces, CFP, is the director of research for Pinnacle Advisory Group, a private wealth management firm located in Columbia, Maryland that oversees approximately $850 million of client assets. He is the publisher of the e-newsletter The Kitces Report and the blog Nerd’s Eye View through his website www.Kitces.com. Kitces is also one of the 2010 recipients of the Financial Planning Association’s “Heart of Financial Planning” awards for his dedication to advancing the financial planning profession. Follow Kitces on Twitter at @MichaelKitces.