It's often said that Social Security is the third rail of American politics: touch it and you die. Politician's fears are justified as this topic impacts almost every American and the situation doesn't have any easy solutions; at least none that would make the majority of Americans happy. But if we turn to Social Security recipients, the justification for fear depends on individual situations. (Learn more in Introduction To Social Security and Top 6 Myths About Social Security Benefits.)
Social Security Basics
Social Security has been in a cash-flow positive position basically since it started. It has more money coming in through the FICA payroll tax that is going out to recipients. The extra money is held in the Social Security trust fund, although it's not just sitting there. It's loaned to the Treasury through the sale of special bonds and the Treasury spends it as part of the overall federal spending. This is why some people refer to the trust fund as a bunch of IOUs.
From Surplus to Deficit
What's about to change is that the surplus is about to become a deficit. The reason is that the baby boomer generation is about to retire. As they do, there will be an increase in the people receiving benefits and a reduction in those that pay into Social Security.
Depending on who's doing the projection, the turn from positive to negative could happen anywhere from next year to 2016. But everyone's projecting that soon, the revenues won't cover the expenses. At that point, Social Security will start calling back those special bonds in the trust fund. Some think this isn't a problem as the trust fund securities can be cashed in and fund the deficit until, again depending on who you listen to, 2037. Then something will have to be done.
However, the federal government has to pay the money back into the trust fund so that those that receive Social Security will still get their checks. To do that they can either increase taxes, decrease spending or add to the deficit by borrowing. It's pretty easy to see why politicians don't want to touch this issue.
And to make things worse, the federal government won't have the Social Security money that comes in from the trust fund. So that lack of income on top of starting to repay the trust fund for past IOUs means they will have to come up with even more money to fund Social Security. With less coming in and more going out, it's a double hit. As we are currently running record deficits already, this isn't good news for anyone.
Should you be concerned?
If you are over 65 and collecting Social Security, this probably won't impact you much. It's very unlikely that politicians will cut your benefits significantly - regardless of the budget and deficit impact. However, the odds on getting more benefits in the future are slim and there is always a chance of some tinkering with things like the cost of living adjustment. But politicians know that seniors vote, so the impact will likely be minimal.
If you are a baby boomer, ages 45 to 65, the closer to 65 you are, the higher the probability you will see your full retirement as promised. As some are just hitting retirement age, the amount of money that needs to come from the Treasury to repay the trust fund bonds will be small at first, and the changes in cash flow shouldn't put undue burdens on the system. But it will grow as more baby boomers retire.
For Generation X, ages 24 to 44, the matter seems to become more sticky. The impact on the deficit of paying back the IOUs will grow, and by the time all Gen-Xers hit their retirement age of 67, the trust fund will be gone and the accounting magic will turn into just a normal deficit. The difference is moot as the money is coming from the taxpayers regardless of whether they are repaying the bonds or just paying the bill directly.
However, there will be a point when the amount they will be paying into this program will become an issue. When that happens, there are a couple of options, none of which are great. They can increase the FICA tax, increase the retirement age or reduce the benefits. Obviously, a combination of the three would be a compromise worth looking at.
For Generation Y and the following generations this issue should calm down as the population rebounded in Gen Y, which will increase receipts, and the baby boom will start dying off, relieving the system of their benefits. Also, the solution will have been worked out by then, so they will be able to adjust to the changing conditions and not get caught depending on Social Security benefits that may not be there.
So while there are some issues with Social Security for some generations, the bigger issue that will impact us all is where is the money coming from to pay the existing IOUs until 2037? That's a problem with deficits as far as the eye can see and a record national debt. Talk about your third rails. No one wants to touch this one either.
For more, read Ten Common Questions About Social Security and How Much Social Security Will You Get?