On Aug. 14, 1935, U.S. President Franklin D. Roosevelt signed into law the Social Security Act. Originally implemented to assist older Americans by paying them a continuing income upon their retirement, the program was later amended to extend benefits to the spouse and minor children of retired workers, workers who become disabled, families in which a spouse or parent dies, and, in the 1960s, health coverage.

Key Takeaways

  • Social Security benefits are funded by a dedicated payroll tax, which workers pay into as they earn income.
  • Social Security is a pay-as-you-go system, with contributions paid in today funding the benefits being paid out.
  • As baby boomers retire, the ranks of those receiving benefits will swell, while those paying taxes will become a smaller percentage of the population.
  • Due to demographic change, there is a risk that the system will run short of money because less will be paid in than is paid out.

Understanding Social Security

The Social Security program is funded through the Federal Insurance Contributions Act (FICA) tax, a dedicated payroll tax. You and your employer each pay 6.2% of your wages, up to the taxable maximum of $142,800 for 2021 and $147,000 for 2022.

If you are self-employed, you pay the entire 12.4%; however, you can deduct half of the self-employment tax as a business expense. Under the law, Social Security is financed by this designated tax, and any surplus money that isn’t paid out in benefits is used to buy U.S. government bonds held in the Social Security Trust Fund.

The money that you pay through taxes is not the same money you will receive later in life. Instead, Social Security is primarily a pay-as-you-go system, where the money you and your employer contribute now is used to fund payments to people who currently receive benefits, including those who have retired or are disabled, survivors of workers who have died, dependents, and other Social Security beneficiaries.

2033

The year that the Social Security Administration estimates that funds in the Old-Age and Survivors Insurance Trust Fund (used to pay retirement benefits) will be depleted.

The Problem With Social Security

Americans are having fewer children and living longer, both of which contribute to an aging population. Baby boomers (those born between 1946 and 1964) are retiring at a record pace.

As of 2020, 17% of the population is age 65 and over, and by 2060, it is estimated that it will rise to 24%. At the same time, the working-age population will be getting smaller, from about 62% today to 57% in 2060.

These trends result in declining worker-to-beneficiary ratios. As we move forward, there will be fewer people putting money into the Social Security system and more people taking money out. Because of these factors, the Social Security Administration (SSA) estimates in its 2021 report that all the money in the combined Social Security Trust Funds will be exhausted in 2034, at which time the continuing tax income will be able to pay 78% of the scheduled benefits.

The report notes that the COVID-19 pandemic had a material short-term impact on the estimates. However, it also adds, "the pandemic will have no net effect on the individual long-range ultimate assumptions." However, they do plan to continue to assess what the long-term effects might be.

Full retirement age is 67 years old for those born in 1960 or later.

Possible Solutions

Fortunately, that’s a worst-case scenario. Social Security is nowhere near bankruptcy, and it has nearly two decades to act before funds are completely depleted. Increased taxes (including raising the income level after which no more taxes are due), benefit cuts, and upping the age at which people can start collecting benefits are all changes that, alone or in concert, could be implemented to make up any future shortfalls.