• Investing & Markets

How Do We Fix Social Security, and How Broken Is It?

September 8, 2011 | Craig Birk, CFP®

Social Security was officially created in 1935 under Pres. Franklin D. Roosevelt. It was, and is, designed to be a social safety net to ensure people who work have some basic level of income in retirement. Working people contribute to the fund and older people receive payments.

But, over time, the ratio of contributors to recipients has shifted, and will continue to shift, dramatically, which is obviously problematic. As more Baby Boomers retire and life expectancies increase, the problem is only going to get worse. The ratio of contributors to recipients has shifted from 16:1 in 1950 to around 3.3:1 for most of the ‘80s, ‘90s and 2000s, and is expected to inch slowly toward 2:1. A good part of this change will happen in the next 25 years.

The latest estimates suggest that the Social Security trust fund will begin to spend more money than it receives in 2016. Current projections suggest it will not be able to make the full payments promised starting in 2037. This does not mean it won’t be able to make any payments, just not the full amount.

Suggestions that today’s workers won’t get any Social Security are greatly exaggerated. But it is likely that either the payments will be reduced or taxes will go up.

How the Government May Approach the Problem

Currently, it is estimated that the problem could be eliminated by increasing the Social Security tax rate two percentage points or decreasing benefits 13 percent. The government can also raise the “Normal Retirement Age” which was already done once, in 1983, when the full retirement age was increased from 65 to 67 depending on when you were born. Politically, this may be a feasible and popular choice.

Another politically popular choice may be to reduce or eliminate the Cost of Living Adjustment (COLA) rate. People tend to underestimate the impact of inflation so they may not get as upset about this change, even though it would be a big reduction in benefit. Social Security income could also be made taxable for low-income retirees. This seems politically unlikely.

The government can also always print more money to pay the benefits. This would cause inflation that would essentially reduce the actual benefits received as well as other problems. Hopefully this will not be the solution.

What to Expect

This is only my opinion, and it may be wrong, but I think it is safe to plan to receive most of the Social Security benefit you would get under the current system. If you are already over 60, it is unlikely you will have any benefit reductions, though it is possible the COLA is reduced somewhat.

When choosing when to start taking benefits, choose the option that maximizes the total amount you would expect to receive. It isn’t yet time to take payments earlier because of concerns about solvency of the system.

If you are between 40 and 60, it probably makes sense to assume you will face a modest tax increase while you are working or some reduction in Social Security benefits. Again, this is a complete guess, but something like a 10 percent reduction in inflation-adjusted benefits may be a good working assumption.

Many people under 40 assume they will get no benefits and I think this is too pessimistic. Still, to be prudent, it may make sense to assume a 15-20 percent reduction in expected benefits (or a higher tax rate on your remaining working years).

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