Most people in this country think that Social Security is in a great deal of trouble, even on the brink of bankruptcy.
They worry about its ability to make benefit payments for their entire retirement. Younger people, who are decades away from retirement, worry whether Social Security will even exist when it is time for them to retire.
Reading the latest Social Security Trustees Report should put most of those worries to rest.
One of the main focuses of the report, published annually, is on the ability of Social Security to meet all its financial obligations over the next 75 years.
Social Security is going to be around in one form or another for a long time, probably well into the next century.
Indeed, the solution to fixing its long-term funding issue is simple. But just because it is simple doesn’t mean that it is easy.
The worst-case scenario would entail a cut in benefits for everybody, but that won’t happen for at least another 18 years. If nothing is done to fix the system, then in the year 2034 everybody’s benefits would have to be cut by about 25%.
In other words, taxpayers would receive 75% of what they should have been paid. Once these benefit cuts are made, Social Security would be able to make all benefit payments going forward until 2090.
So, over the next 75 years, the worst thing that could happen is a 25% cut in benefits 18 years from now.
There are other options.
The report highlights several options that could fix the funding shortfall with no benefit cuts.
The total deficit or funding shortfall is 2.66 % of taxable payroll. The simplest way to erase that deficit is to increase the payroll tax or FICA tax by a total of 2.66%.
That tax increase could be split evenly between employers (1.33%) and employees (1.33%). The FICA tax for employees stands at 6.2% of earnings.
Employers also pay the same rate of 6.2%. Increasing the FICA tax for both employers and employees by 1.33%, would bring it up to 7.53% and eliminate the need for any benefit cuts through 2090.
RAISING THE CAP
Increasing taxes by this amount doesn’t seem like a viable option. The other option that would have the biggest impact on reducing the Social Security funding shortfall involves the earnings cap.
To be sure, the Social Security Administration said in October that this cap will increase next year to $127,200 from $118,500.
If clients earn less than this threshold, wherever it is set, they would pay the 6.2% FICA tax on all their income. If their earnings exceed the threshold, anything above that level wouldn’t be subject to the tax.
About 6% of all wage earners in this country have earnings that exceed $118,500.
And increasing the cap to $127,200 will make more taxpayers subject to the tax or about 12 million more people, according to the SSA.
But simply eliminating the earnings cap, so that everybody pays FICA taxes on all their earned wages, would resolve 70% to 90% of the program funding issue with no benefit cuts.
Eliminating the earnings cap doesn’t appear to be a viable political option either. But a combination, raising FICA taxes a little bit along with a raise in the earnings cap, could be more palatable politically and could accomplish the goal of eliminating the funding deficit with no benefit cuts for 75 years.
Here is how it could work.
Increasing the FICA tax by, say, four-fifths of a percentage point, for both employers and employees to 7% from 6.2% would resolve about 60% of the long-term funding issue. It is less than a one percentage point increase for individuals and for companies and hopefully more acceptable to politicians and voters.
Just doing this by itself would extend the time before benefits would have to be cut until 2052 instead of 2034 or by an additional 18 years. In addition to the small FICA tax increase, if the earnings cap is increased again to, say, $350,000, that should eliminate the deficit with no benefit cuts for the next 75 years.
This is just one potential solution. With this, everybody plays a part in the solution, but wealthy people play a bigger part.
Everybody is affected because FICA taxes would be increased by 0.8% for everyone. Wealthy people would experience a higher tax increase measured in dollars because much more of their earned income would be subject to FICA taxes when the earnings cap is raised to $350,000.
Compromise has always been a major part of our political system, though recently it has been hard to come by. A good compromise involves both sides making a sacrifice and both sides receiving a benefit.
That is exactly what happens with this proposed fix. The people who aren’t considered wealthy make the sacrifice of paying more FICA taxes with the 0.8% tax increase, but they also gain because their retirement benefits won’t be cut.
A benefit cut for many of these people could be especially harmful, making it much harder for them to maintain a decent standard of living in retirement. The wealthy also make the sacrifice of paying the higher FICA tax as well as paying that higher tax on more of their earned income.
But they also would benefit because when it comes time for them to claim Social Security, their retirement benefits would be bigger because of the additional FICA taxes they had to pay.
The longer we wait, the more expensive it becomes to fix the system. Politicians need to compromise and fix the system now.
In this case, it doesn’t pay to wait.
Brian Doherty is a national speaker on Social Security and author of Getting Paid to Wait.
This story is part of a 30-30 series on Social Security. It was originally published on Nov. 2.
Register or login for access to this item and much more
All Financial Planning content is archived after seven days.
Community members receive:
- All recent and archived articles
- Conference offers and updates
- A full menu of enewsletter options
- Web seminars, white papers, ebooks
Already have an account? Log In
Don't have an account? Register for Free Unlimited Access