As your financial advisors, Capital Advantage feels that it is important that we address current conversations surrounding Social Security. With numerous headlines speculating on the insolvency of this vital program, we want to provide you with an informed perspective.1
Debunking the Myth: Social Security’s True State
Separating Fact from Fiction: For years, reports from the Social Security Board of Trustees have indicated that the trust fund might be depleted by the 2030s, sparking fears that benefits might suddenly end. Contrary to these fears, Social Security is not on the brink of vanishing. While substantial changes are needed, the system will persist, though it may involve some benefit reductions.
Understanding the Funding Mechanism: Social Security is unique among government programs because it is self-funded. Revenues come from payroll taxes and other dedicated sources, which are used to pay benefits. This structure means that the program does not rely on Congress for yearly funding and cannot draw from other federal funds. Consequently, any financial shortfalls must be managed internally.
Historical Context and Present-Day Challenges
1980s Reforms – A Precedent: In the early 1980s, with Social Security facing projected deficits, Congress enacted significant reforms. These included raising payroll taxes, increasing the full retirement age (65), also known as the normal retirement age, and introducing a tax on benefits. These measures successfully generated surpluses, leading to a robust trust fund, which had amassed nearly $3 trillion by the end of 2020.
Persistent Issues and Miscalculations: Despite these reforms, issues have resurfaced. The primary flaw in the 1980s solution was the assumption that wage growth would be evenly distributed. In reality, wage growth has been concentrated among higher earners, reducing the percentage of total wages subject to Social Security taxes as payroll taxes are capped. This imbalance has contributed to the current funding challenges. See chart below.
Social Security Tax as Percent of Total Wages
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The Tipping Point of 2021: In 2021, Social Security faced a pivotal moment when benefit payments surpassed revenues for the first time since the early 1980s, leading to withdrawals from the Social Security trust fund assets to make up the difference. This situation has intensified concerns about the system’s sustainability.
Potential Reforms and Their Implications
Exploring Proposed Solutions: Numerous solutions have been proposed to rectify the projected shortfall. These range from adjusting the benefit formula and reducing cost-of-living adjustments (COLA) to increasing payroll taxes and removing the payroll tax cap. Each proposal addresses different aspects of the shortfall, with varying degrees of impact on beneficiaries.
Below is a list of proposals and the impact of each:
Proposed Solutions to Projected Social Security Shortfall
See full analysis at ssa.gov/OACT/solvency/provisions/.
Projected Changes by 2033: If no major reforms are implemented, the Trustees project will cover only about 79% of scheduled benefits by 2033. While this is the current trajectory, adopting one or more of the proposed measures could alter this path, ensuring the stability of a crucial income source for our nation’s retirees.
Strategic Considerations for Your Retirement
When to Start Collecting Benefits: A common concern is whether to start collecting Social Security benefits early, fearing the system’s potential insolvency. However, starting early generally results in reduced monthly benefits. Given the anticipated changes, consulting with your financial advisor at Capital Advantage to determine the best time to claim benefits is crucial.
Tailored Financial Planning: Each client’s situation is unique. Personalized advice from your financial advisor is essential to navigate these changes effectively. Our team is committed to helping you understand how potential reforms may affect your retirement plan and to assist you in making informed decisions.
Conclusion
Although significant changes to Social Security are forthcoming, the program will not abruptly end. It will still provide benefits, though there may be potential reductions. By staying informed and planning strategically, we can navigate these adjustments together. Please feel free to contact us with any questions or to schedule a consultation.
Sources:
- www.cnbc.com/select/will-social-security-run-out-heres-what-you-need-to-know
- www.nuveen.com/en-us/insights/advisor-education/busting-the-myth-of-social-security-insolvency
