The long-term funding shortfall threatening Social Security has garnered so much public notice that consistently overwhelming majorities of poll respondents profess to be worried about the system a "great deal" or a "fair amount."
And they should be. The 2022 annual report from Social Security's Board of Trustees projected that growing annual deficits, caused by the rising proportion of benefit recipients relative to contributing workers, would deplete the reserves of the main Social Security trust fund within 12 years, requiring benefit cuts if fund receipts are not increased.
One silver lining is that the projected depletion date has moved back by a year since the 2021 trustees report, to 2034, as a result of stronger-than-expected economic growth.
There are others. The scale of the long-term funding gap is still such that fixing it over time is reasonably affordable, though the cost increases the longer the hard choices are put off. In the past, Congress acted to shore up funding for the Social Security system whenever it faced insolvency. It will soon face pressure to do so again from beneficiaries who have never before accounted for so large a share of the U.S. population.
- The 2022 Social Security Trustees Report projects Social Security's main trust fund will run out of reserves in 2034, a year later than estimated in the 2021 report.
- The projected deficits are the result of the aging U.S. population, as Baby Boomer retirements accelerate the decline in the number of workers supporting each retiree.
- Once the retirement trust fund is depleted in 2034, ongoing payroll tax receipts are expected to cover 77% of scheduled benefits.
- Funding shortfall solutions include payroll tax hikes and benefit cuts, such as the raising of retirement age. Investing a portion of trust fund reserves in stocks may improve returns, provided Congress first acts to ensure the system's solvency.
- The cost of the measures required to address the shortfall rises the longer changes are delayed.
What Is Social Security?
The Social Security program is managed by the Social Security Administration (SSA). It is commonly known as the Old Age, Survivors, and Disability Insurance (OASDI) Program. It consists of two funds:
- The Old Age and Survivors Insurance (OASI) Trust Fund for retirees
- The Disability Insurance (DI) Trust Fund for individuals with disabilities
These two funds are legally separate and their financial prospects differ significantly.
Social Security was launched during the Great Depression as a safety net for older adults. The program was designed to function as insurance, which is why Social Security payments are called benefits.
How Does Social Security Pay the Benefits?
Social Security benefits are funded by ongoing payroll tax receipts and accumulated reserves in a pay-as-you-go system. That means everyone's contributions are pooled and a recipient can receive benefits greater than their contribution and associated fund returns.
The system accumulated a considerable surplus in recent years that is now projected to rapidly deplete as annual benefit payouts start exceeding tax receipts and the trust funds' interest income.
As the huge Baby Boomer generation continues to retire, Social Security outlays are expected to continue to increase at a much faster pace than its receipts, until Congress fixes the funding—or else until the reserves are spent and benefits cut.
By 2031, when the youngest Boomers reach age 67 qualifying them for full Social Security benefits, there will be 75 million Americans age 65 and older, up from 39 million in 2008. Over time, the growing number of retirees is leaving fewer workers to support each benefit recipient with payroll contributions. The beneficiary-to-worker ratio is expected to rise from 35 per 100 in 2014 to 44 per 100 in 2030.
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The Greenspan Commission
This wave of Baby Boomer retirements was not unexpected; in fact, it was planned for in 1983, when Ronald Reagan named Alan Greenspan to lead the bipartisan National Commission on Social Security Reform. The Greenspan Commission, as it came to be known, produced a funding fix to address the trust funds' imminent depletion and leave them in a better position in the long run.
One of the biggest Social Security changes made by Congress on the Greenspan Commission's recommendation was the change in the age at which Americans qualify for full Social Security benefits from 65 to 67 for those born in 1960 or later.
Another key was increasing Social Security tax rates to build up the associated trust funds. In 1983, the tax rate was 5.4% for employees and employers. It rose to 5.7% in 1984, then 6.06% in 1988, and 6.2% in 1990 (where it remains today).
The year Social Security's OASI Trust Fund for retirement benefits is expected to be depleted.
Today’s Social Security Finances
As a result of the 1983 changes, the Social Security trust funds have accumulated significant reserves after running annual surpluses every year from 1982 to 2020. The program's annual deficit in 2021 was projected to narrow slightly in 2022, then widen significantly in each of the next nine years. More numbers from the 2022 annual report of the trust funds' trustees:
- Social Security's two trust funds held a combined $2.85 trillion at the end of 2021.
- Total expenditures in 2021 were $1.14 trillion, and total income was $1.09 trillion.
- The OASI trust fund is expected to run out of reserves in 2034, while the DI trust fund is now projected to have sufficient reserves for the next 75 years. The 2021 report predicted OASI would be depleted in 2033, and DI reserves in 2057.
- On a combined basis, the two trust funds are now projected to be exhausted in 2035, a year later than estimated in 2021.
- When the OASI trust fund is depleted in 2034, continuing fund receipts are expected to cover 77% of scheduled Social Security benefit payments.
Clearly, a fix is needed to avoid a reduction in Social Security benefits when the trust funds run out of money. Many solutions have been proposed to ensure Social Security remains solvent. Congress may opt for some combination of the measures below when it tackles the issue.
Raise the Payroll Tax Rates
Payroll taxes would have to rise by 3.41 percentage points to 15.81% in 2022 to eliminate Social Security's projected actuarial deficit over the next 75 years and ensure the program has the funding to pay scheduled benefits in full over that time frame. At the moment, the payroll tax rate is 12.4%, with workers contributing 6.2% and employers matching that contribution.
Eliminate the Cap on Taxable Income
There's a cap on annual income subject to Social Security payroll taxes, which is also used in calculating Social Security benefits. In 2022, the cap is $147,000. That cap increases to $160,200 in 2023.
According to a December 2021 Congressional Research Service report, eliminating the payroll tax cap while leaving in place current rules capping high earners' benefits would address 73% of the projected 75-year shortfall. Payroll tax rates could then be raised from 12.4% to about 13.36% to eliminate the shortfall in its entirety.
Raise the Retirement Age
Those born in 1960 qualify for the reduced Social Security benefits available at age 62 in 2022, while people born in 1955 and 1956 will qualify for the full benefits available at age 67 no later than 2023. Some have suggested raising the full retirement age to 69 or 70, effectively an across-the-board benefits cut.
The SSA estimates based on the assumptions in the 2022 Trustees Report that gradually raising the full retirement age to 69 for those born in 1972 or later and increasing it by one month every two years thereafter would eliminate 38% of the system's long-term funding shortfall. The SSA's Office of the Chief Actuary regularly posts estimates of financial effect for a variety of Social Security reform proposals and provisions.
Invest a Portion of Trust Funds' Reserves in Stocks
Social Security trust funds invest receipts not immediately needed to pay benefits in special-issue U.S. debt obligations. (By law they may also hold marketable U.S. debt securities, and have done so in the past.) In contrast with the Treasury's marketable securities, which are only guaranteed to return face value upon redemption, special-issue debt sold to the Social Security trust funds may be redeemed at face value at any time. In practice, redemptions prior to maturity happen only if required to cover current costs, not to reinvest proceeds at a higher yield as rates rise.
Because stock-market returns, on average, have historically outpaced those from fixed-income investments, some have suggested the Social Security trust funds invest a portion of their reserves in stocks (most likely through broad-market exchange-traded funds) to increase their investment income.
Any change would only be meaningful assuming a fix to the system's projected funding shortfall since otherwise the reserves will be depleted too soon for returns on them to matter. The policy change would also increase the trust funds' risk since equity returns are more variable. A 2019 Congressional Research Service report concluded that risk would be manageable for a gradually increased equity allocation up to a maximum of 40% of the reserves. Risks that an investment in equities on that scale would interfere with the operation of private companies or securities markets could also be addressed, according to the report.
One study using Monte Carlo simulations to estimate the long-term performance of trust fund reserves with a 40% allocation to equities found the median outcome was a reserve ratio of 330% of next year's costs at the end of the 75-year projection period. In contrast, the median outcome for a portfolio made up entirely of U.S. government debt special issues was reserves depletion in year 74 of the simulation. The simulations assumed future annual equity returns averaging 6.6% versus a historical average of 9.5% as of 2017.
The Bottom Line
Without meaningful Social Security funding changes in the next 12 years, reduced benefits could be still paid from ongoing payroll tax revenue. The sooner Congress fixes the system's deficits to avert that possibility, the better off the system and its recipients will be.