Changes to Social Security

• The revenue generated by taxes, as stipulated by the Federal Insurance Contribution Act, is used to cover the Social Security benefits owed to Americans each year
• Reports from the last five years have suggested that the combined old-age, survivors, and disability insurance trust funds (OASDI) are projected to run out between 2033 and 2037.  There could be changes to Social Security.

For many of us, Social Security makes up a significant portion of our retirement income plan. But, we’ve heard concerns raised about its long-term viability and potential changes to Social Security that will be required to keep it alive.

Based on the history of the program and the government’s commitment to provide support to the elderly and disabled, we believe that Social Security will remain an important source of retirement income in the future. The question is then not a matter of existence, but instead one of value. That is, can we expect Social Security benefits to continue according to today’s trajectory, or will they be reduced in the future?

First, let’s take a look at the financial status of the Social Security program. There are three important drivers: (1) tax revenue, (2) benefits owed, and (3) the trust funds.

To fund the Social Security program, individuals and employers are taxed a combined 12.4% per year, as stipulated by the Federal Insurance Contribution Act (FICA). The revenue generated by these taxes is used to cover the Social Security benefits owed to Americans each year. If the tax revenue is insufficient, or less than the benefits, in any given year, the trust funds are available to pick up the difference. Ultimately, the financial status of the program is measured by its solvency, which is the ability to draw on the Social Security trust funds to pay full benefits.

When tax revenue exceeds benefit payments, the difference is deposited into the trust funds and they increase in size. The opposite is true when benefits owed exceed tax revenue, at which point the trust fund is used to cover the difference. The latter occurring in any given year is not necessarily a problem, unless it is projected to persist long into the future. Eventually, if benefits are consistently greater than revenue, the Social Security trust funds risk being depleted.

Reports from the last five years have indicated that the combined old-age, survivors, and disability insurance trust funds (OASDI) are projected to run out between 2033 and 2037. At that point, we’d be relying only on Social Security tax revenues, which would cover 75-80% of benefits owed. The actuaries at the Social Security Administration (SSA) have also outlined alternative scenarios, ranging from trust funds being depleted even earlier to not being depleted at all.

Assuming the more favorable scenario doesn’t materialize, ensuring benefits are fully payable and avoiding depleting the trust funds would require making changes to Social Security law.

Looking back at the history of Social Security, full benefits have always been paid in a timely manner since the program was created in 1935. At times, this has required changing Social Security by amending the Social Security Act, such as in 1977 and 1983. In 1977, changes were made to the way benefits are indexed from one generation to the next. And, in 1983, the full retirement age was increased from 65 to 67 and taxation of benefits was introduced.

Within the next 20 years, we should expect to see more changes to Social Security to reflect the SSA’s anticipated scenarios. While nothing has been decided, here are some options being considered:

1. Reduce the annual Cost of Living (COLA);
2. Slow down growth of benefits from one generation to the next;
3. Increase the full/normal retirement age and/or the earliest eligibility age;
4. Reduce benefits for family members;
5. Increase payroll taxes;
6. Allow trust funds to be invested in equities and corporate bonds instead of only government bonds to catalyze greater potential returns; and
7. Increase taxation of benefits or reduce tax breaks at lower-income thresholds.

So what’s the takeaway?

We should all be prepared for potential reductions to Social Security benefits, especially if retirement is still years away. It’s important that you diversify your retirement plan in order to optimize your income in retirement and protect yourself from unforeseen changes to Social Security and like programs.  To do so, we recommend not only creating a holistic retirement plan, which may include an income annuity to guarantee retirement income that will meet your spending in retirement. That way, you’ll be prepared for the unexpected and otherwise be able to pleasantly surprise yourself with an extra couple of vacations per year.

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