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, more recently, health coverage.
- 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 $137,700 for 2020 and $142,800 for 2021.
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.
The year in which the Social Security Administration estimates that it will go bankrupt unless changes are made to how the system is funded.
The Problem With Social Security
So what’s the problem? Basically, demographics.
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 2018, 16% of the population is age 65 and over, and by 2060 it is estimated that it will rise to 23%. 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 estimates in its 2020 Annual Report that all the money in the Social Security “bank account” will be exhausted in 2035, when it will have only about 79% of what it should pay out that year. (The report makes a point of noting that “the projections and analysis in this report do not reflect the potential effects of the COVID-19 pandemic on the Social Security and Medicare programs. Given the uncertainty associated with these impacts, the Trustees believe that it is not possible to adjust their estimates accurately at this time.”)
That means that without any changes to the system, if you’re in your 40s or 50s today, you could conceivably not receive your full Social Security benefits during retirement, even though you’re paying into the system now.
Full retirement age is 67 years old for those born in 1960 or later.
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 (66 in 2020 but rising to 67 by 2026) are all changes that, alone or in concert, could be implemented to make up any future shortfalls.