Frequent news headlines point to fears about the health of the Social Security retirement benefits system. Reports directly from the system's Board of Trustees indicate that the reserves for Social Security are estimated to be depleted by 2035.
Many people have interpreted this to mean that Social Security benefits will not be available after this point. However, the way that the Social Security benefit system is funded provides for on-going benefits in a manner that may surprise some people.
I explore the current state of Social Security and its challenges below. See how Social Security changes could impact your retirement planning.
How is Social Security funded?
It's important first to understand how Social Security benefits are funded. The majority of benefits paid out in a given year come from payroll taxes paid by current workers and employers. Employers and employees each pay a 6.2% payroll tax on wages earned up to $168,600 per worker in 2024. This combined tax of 12.4% generated $1.23 trillion dollars available for benefit payments for 2023.
The Social Security Trustees then maintains a reserve to pay out any remaining benefits due that are not covered by incoming payroll taxes.
As of the most recent report, current payroll taxes and reserves are expected to be sufficient to pay out 100% of all Social Security benefits through 2034.
What happens in 2035?
According to current estimates, in 2035 incoming payroll taxes would not be sufficient to cover full benefits, and the reserves would be exhausted. However, incoming payroll taxes are expected to cover 83% of expected benefit payments.
Which means, rather than Social Security benefits disappearing, retirees would still expect to receive 83% of their benefits for several years, and this assumes that Congress takes no action to help the Social Security system.
The Trustees additionally estimate that without action, expected benefit coverage would fall from 83% to 73% in 2098.
So, even if the reserves are depleted and Congress does nothing to address Social Security, retirees can still expect to receive the majority of their benefits from the remainder of this century.
What can Congress do to fix Social Security?
While those planning for retirement should take some confidence that the majority of their Social Security benefits will still be available in the future, no one is likely happy about the prospect of a 20% reduction in their expected benefits. Congress has several policy options available that can reduce or eliminate the gap.
Raise payroll taxes - An increase of the current payroll taxes by an additional 3.3% would be sufficient to close the benefit gap.
Increase Social Security Wage Base - Currently, wages only up to $168,600 per worker are subject to Social Security payroll taxes. Congress could increase or eliminate this limit, so that more wages are subject to Social Security taxes each year.
Increase Full Retirement Age - Full retirement age is currently set at age 67 for workers to receive their full Social Security benefit amount. Congress could consider increasing FRA to 68 or 69, in a phased approach, that would create more time for the reserve build-up to pay future benefits. This may reflect the aging of our society more accurately.
Change Cost of Living Adjustments - Policy makers have considered changing the methodology on how annual cost of living adjustments are calculated to better reflect the impact of inflation. Certain methodologies would reduce future adjustments to increase the sustainability of the system.
Each of these options has its pros and cons. Current workers are likely less enthusiastic about increasing taxes on their pay, while current and near retirees are likely less enthusiastic about changes to FRA or COLA adjustments.
But the fact remains that Congress has many options at its disposal, and a combination of smaller changes in multiple aspects of the current system could be sufficient to reduce the likelihood of cutting expected benefit payments. This is particularly true the sooner Congress decides to act.
The bottom line
The thought of losing Social Security benefits has caused concern for many people in or near retirement. However, I hope this review has helped to put the current challenges for Social Security into perspective. The majority of current and near retirees are likely to receive their full benefits for at least the next decade, and the majority of their benefits beyond that point, even if Congress does not act.
And with several policy options at their disposal, Congress has the tools available to help shore up the remaining gap.
What can you do now?
One of the best ways to help remain confident about your future is to review your plans with a professional. Schedule a review with me where we can stress test your retirement plan against different Social Security scenarios, so you can learn what, if any, adjustments may be needed to keep you on track for a great retirement.
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About the Author:
David Edmisten, CFP®, is the Founder of Next Phase Financial Planning, LLC, a financial advisor in Prescott, AZ. Next Phase Financial Planning provides retirement, investment and tax planning that helps corporate employees retire with both financial and lifestyle security.
Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, and CFP® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.