It is fashionable these days among 20- and 30-somethings, and some older Americans, to say they never expect to see a dime from Social Security. Why should they, they ask, since the system is going broke?If they actually believe this, they’re wrong. Social Security is not going broke, at least not in the sense of having no ability to pay. As long as the payroll tax remains in place and there are people working, Social Security will have money coming in to pay benefits.
What the current system won’t have, though, is enough to pay all the benefits now promised. Beginning sometime this decade, according to current projections, there will be less money coming in each year than the system will be obligated to pay out. That means calling in the loans it made to the rest of the federal government during the years in which payroll tax revenues exceeded benefit payments.When these IOUs are repaid, the system will have enough revenue to pay about three-quarters of what it is now promising, and it should be able to pay that amount indefinitely. The questions those younger workers—and others paying into or drawing on Social Security—should be asking are: How much of a benefit will I get, and how much will it cost me to earn it?
The Likely Fixes: Who Wins, Who Loses
This is important because Social Security today provides about 40 percent of the income received by Americans 65 and older, and it provides nearly half the income of elderly women, according to a recent study by the Employee Benefit Research Institute in Washington. With longer life expectancies and the fading of traditional pensions for private-sector workers, Social Security seems likely to make up an even larger share of retirees’ income in the future.
Changes that would bring the system into balance—that is, enable it to pay the benefits it promises—fall into two broad categories: reducing the promised benefits or raising taxes workers pay into the system. But these seemingly similar proposals would have substantially different consequences for retirees with different earnings histories and at different ages in retirement. “There are questions within generations and then across generations,” said Melissa Favreault of the Retirement Policy Project of the Urban Institute in Washington.
Hardest Hit by COLA Cuts: Older Retirees
A recent analysis by the Retirement Policy Project concluded that reducing by one percentage point the annual cost-of-living adjustment (COLA) every Social Security recipient now gets would eliminate more than three-quarters of the funding deficit over the next 75 years. If such a cut were made now, however, benefits for retirees who are 80 years old in 2050 would be more than 20 percent less than what they would be getting under a full cost-of-living adjustment (COLA). Retirees aged 65 to 69, on the other hand, would see a reduction of less than 8 percent, based on the Retirement Policy Project’s calculations. The lower COLA has a cumulative effect, like a savings account that pays 2 percent instead of 3 percent—the longer you leave your money there, the further behind you get. For the same reason, the impact on younger retirees would be less.
The Financial Planning Association, a Denver-based trade group for financial planners, offers its own estimates of the effect of a lower cost-of-living adjustment on different age groups. It uses somewhat different assumptions than the Retirement Policy Project, such as a retirement age of 65 and a COLA reduction of 0.33 percent. Under the present system, according to the FPA’s calculations, a worker retiring at age 65 in 2029 and promised benefit of $1,864 a month would get that, but the worker’s child, retiring at 65 in 2059, would get only $1,482. If the COLA were reduced slightly, the current worker’s benefit would fall to $1,848 but the child’s would rise to $1,524.
Hardest Hit by Raising the Retirement Age: Retirees Ages 65 to 69
“Full retirement age,” as Social Security calls it, is now 66 for everyone born between 1943 and 1954 and 67 for everyone born in 1960 and later. Workers retiring earlier than full retirement age receive a reduced benefit. Those retiring later, up to age 70, currently get a larger benefit.
Raising to 68 the age at which retirees can receive full benefits would hit retirees ages 65 to 69 the hardest. Many who start to collect benefits early work at least part time. They would be subject to the retirement earnings test, which reduces benefits for those earning more than a certain amount, for a longer period.
Some proposals would have different effects on low- and high-earners. One proposal would continue to calculate initial benefits for workers in the lowest 30 percent of lifetime earnings as they are now but would change to a less generous formula for higher-paid workers. By 2050, benefit cuts for those workers would range from less than 3 percent to about 18 percent.
Raising Taxes: A Higher Wage Base Would Hit the Affluent Also, taxation of both workers and retirees could be changed. Right now, workers pay 6.2 percent of their wages and employers contribute a like amount to finance Social Security. In 2010, this tax applies only to wages of up to $106,800; earnings above that are excluded. Either the rate or the income ceiling could be increased but raising the wage base would hit the affluent harder than increasing the rate. Retirees with income above a certain level currently pay tax on between 50 percent and 85 percent of their benefits. That rate could be increased.
There are numerous other possibilities. All are likely to get serious consideration as policymakers grapple with Social Security’s future. Some combination is likely to be the ultimate solution. It means that, rather than writing Social Security off, young workers would be well advised to keep informed about the issues so they can at least have an idea of what they will get when retirement time rolls around.
To get a sense of benefits under current law, go to the Social Security Administration’s website at and click on “Estimate Your Retirement Benefits” on the left side of the page. Some private groups, including the Financial Planning Association, offer estimates of future benefits under various scenarios, comparing them to benefits under current law.