Some statistics you need to know

The Future of Social Security

by Gary Foreman

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Dear New Frugal You,
I am 72, an economics major, and am fed up with people like yourself who say young people will have to take up the load on Social Security and play the doomsday effect in 20 years. How about eliminating the wage cap and, quelle horror, tax unearned income for SS?
Disgusted (translated from all caps for readability)

I'm sorry that you're fed up. But, I think that you may be blaming the messenger for facts that you don't like.

Let's begin by examining those facts. To make sure that they're unbiased, all statistics are from the Social Security Administration.

Let's begin by trying to get an understanding of Social Security. At the end of September, 2013, 54,489 million people were receiving benefits at a rate of $725 billion annually. During the same year, approximately 158 million employees and self-employed workers, along with employers, contributed $564 billion to the OASDI trust funds. Source here

In 2012, the average earner will pay $2,522 into SS. A maximum earner pays $4,624. A self-employed maximum earner will pay $11,450. Source here

The Social Security fact-sheet for 2012 describes what to expect. "Social Security is not sustainable over the long term at current benefit and tax rates. Beginning in 2010 and continuing in 2011, the program paid more in benefits and expenses than it collected in taxes and other non-interest income, and the 2012 Trustees Report projects this pattern to continue for the next 75 years.

"The Trustees estimate that the trust funds will be exhausted by 2033. At that point, payroll taxes and other income will flow into the fund but will be sufficient to pay only 75% of program costs." Source here

So now that we understand that it's the Social Security Administration and not me who is predicting a doomsday for Social Security, let's see if we can understand why it's happening.

The SS law was passed in 1933 under different assumptions than we would use today. For one thing, people didn't live nearly as long. Someone who was born in 1930 had a life expectancy of 58 years and would never collect SS.

If he lived to celebrate his 30th birthday in 1930, he had a life expectancy of less than 37 more years, meaning that he wasn't expected to celebrate his 67th. So the average 30-year-old would collect Social Security for less than two years. Source here

Medical science has changed all that. A male turning 65 this year can expect to live another 16 years. A woman has another 19 years on average. So instead of collecting for just a few years, we now have many retirees collecting for decades.

Not only are people living longer, but also baby boomers didn't have as many children as their parents did. As a result, there are fewer workers paying into SS compared to retirees collecting checks.

In 1942, there were 43 workers for every retiree. As recently as 1955, there were over eight workers contributing to Social Security for every retiree. Source here

This is not true today. In 2011, there are just 2.9 workers paying SS taxes to each person collecting benefits. The Trustees project that will fall to 2.0 to 1 in 2034. Source here

Next, remember that SS benefits are indexed to inflation. The SSA expense projections considered inflation rates from 1.8 to 3.8 percent. Source here If trillion dollar deficits continue, that rate is much too low.

Finally, "when the trust fund reserves are depleted, current law requires that benefits paid should match income received." So as long as Social Security is a separate government program (as it is today), it cannot spend money that it does not have. Source here

The facts are fairly clear. If we don't make any changes and the trustees' forecasts are correct, in about 20 years, we'll need to raise taxes and/or cut benefits by about 25 percent. Or abandon SS and replace it with a similar program out of general revenue, which would allow the government to spend more than they take in taxes.

So what about your suggestion, Disgusted? Could we increase the maximum wages that are taxed for SS and also tax "unearned" income? Of course we can. And, I expect that we probably will. Faced with a huge shortfall, Congress will have no choice.

But, benefits will need to be cut, too. If they're going to raise their children and save for their own retirement, it's not realistic to expect two younger workers to support each retiree.

Probably retirees who have accumulated some wealth in their own IRA or 401k will receive lower SS benefits. The argument will be that the "wealthy" don't need SS.

But, it does seem unfair to those who have lived frugally. Not only did they pay into SS, but they also contributed to their own retirement account. That they shouldn't get the benefits they were promised doesn't seem right to me. We're penalizing people for living responsibly and saving for their own retirement.

It also puts to rest the myth that today's Social Security program is a pension plan where you save today to have money tomorrow. Social Security will become a program where government decides who pays how much in taxes and who benefits from those taxes.

As an economist, I'm sure that you understand that the system cannot pay out more than it takes in indefinitely. And that raising the caps and taxing "unearned" income only adds to the total tax burden on the economy.

But you don't have to be Chicken Little to recognize that there's a problem with Social Security and that younger people will probably have to play a part in any solution. Maintaining the current path means that both retirees and younger workers will be pretty unhappy in about 20 years.

Gary Foreman

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, and Gary shares his philosophy of money here. You can follow Gary on Twitter. Gary is also available for audio, video or print interviews. For more info see his media page.

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