What are the chances of relying on Social Security in retirement?

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By: Brandon | BrandonRenfro.com

Is Social Security Going Broke? More importantly, will YOU be able to collect Social Security benefits when you retire? Well, to quote the 42nd President of the United States, that depends on what the meaning of the word is… is.

That’s right. I said it. The point I want to make here is that there is a significant degree of confusion and misinformation regarding Social Security funding.

Let’s go ahead and define the meaning of the word is…

When you ask if Social Security is going bankrupt, what you really want to know is “Will I receive my Social Security benefits?”.  Those two questions are very different and I’ll explain how in this article.

To answer the second question, you need to understand how Social Security funding works, to begin with, and where your benefit comes from.

How is Social Security Funded?

Let’s address the idea of Social Security “going broke”. Social Security doesn’t rely on a sum of money in an account to fund benefits and was never intended to. It simply wasn’t designed that way.

Social Security is a pay-as-you-go system. That means that current workers fund current retirees benefits. When workers pay their Social Security taxes ( OASDI or FICA ) those funds go to current retirees who are receiving retirement benefits.

Let’s talk about that for a minute. When discussed at all, this usually has a negative spin as the unfortunate consequence of financial mismanagement. However, that isn’t the case.

That’s a very good thing too! What that means is that as long as people keep working, you continue to receive retirement benefits. To be clear, that is exactly how the program was designed. Social Security was never meant to be a system by which you save and then withdraw your own contributions later. This design feature makes it literally impossible that Social Security can go broke. It never had any money to begin with.

Does Social Security have a Trust Fund?

Yes. There is a Social Security Trust Fund, and yes, it is projected to go broke. I know that seems counter to what I just told you above but it is an important distinction that I’ll explain.

It’s important to understand what the Social Security Trust Fund is and how it functions… without the political or emotional spin.

Current Social Security taxes fund current benefits. Since I am currently employed and paying Social Security taxes, I am funding a benefit for a current retiree.

I am also building my own CREDITS by which I’ll calculate my own benefit several decades from now. Those benefits will be funded by younger workers, some of which haven’t been born yet. Thanks guys.

The idea is simple enough.

But what happens when current Social Security taxes don’t equal current Social Security benefits? Specifically, if Social Security taxes are higher than current benefit payments, where does the extra money go?

The Social Security Trust Fund.

Any period in which the amount of Social Security taxes collected exceeds Social Security benefit payments, the remainder goes into the Social Security Trust Fund. This has been the case every year since 1982. Every Year since 1982 Social Security has earned more than it has paid out, and the value in the trust fund has grown.

Again, we need to talk about what that really means. You have likely heard that Congress has raided this account and filled it with nothing but worthless IOU’s from unscrupulous legislators. Or something to that tune.

What Happens With the Money in the Social Security Trust Fund?

First, ask yourself what you would want to happen with that money. Should it sit there? There is very little economic rationale for that answer. If the money simply sits there in cash it will continually fall in value due to inflation. You no doubt understand that $1 today doesn’t buy what it did when you were 18.

It would be irresponsible to just let the money sit there then.

Should we invest it in stocks? There’s a more economic rationale for that answer. After all, over the long term stocks have performed quite well on average. Wouldn’t’ it be nice to see the Trust Fund get a good return?

However, stocks are also quite risky and values can fluctuate wildly. Considering all Social Security beneficiaries have a claim to that money it would be impossible to balance the investments in a way that made everyone comfortable. Worse, what if we made a series of really bad investments and lost a lot of that money? The political tension would be enormous. Managing a portfolio of stocks with the American populace as your collective client sounds like a nightmare that would make Stephen King wet the bed.

So what do we do with it then? We don’t want to just let it sit there and deteriorate, but we also don’t want to take on too much risk.

The academic answer here is “invest it at the risk-free rate”. What is the risk-free rate? The current interest rate paid on government bonds. We term it risk-free because the ability to pay principle and interest on government bonds is premised on the tax authority of the federal government. As long as the federal government has the ability to collect taxes, they have the means to repay bonds. I don’t see that going away any time soon.

That is exactly what happens with the money in the Social Security Trust Fund. It is invested in special-issue government bonds. 

This is where the idea of Congress raiding the Social Security Trust Fund comes from. Did Congress borrow billions of dollars from the Social Security Trust Fund? Yes, that is exactly what it means to buy a bond. You loan money to the issuer. That means the issuer is borrowing the money from you. Attach whatever political spin you want on that and you have a good story.

…The Trust Fund then collects interest on these bonds as well.

In 2016, the Social Security Trust Fund earned $88 billion in interest. That is not trivial. I don’t just say that because it is a large amount. Obviously, $88 billion is a lot of money. It is non-trivial because of the impact it has.

What is the Impact?

Total Social Security expenditures for 2016 were $922 billion. Total income was $957 billion. That means that total income EXCEEDED total expenses by $35 billion. Social Security actually made money in 2016. That doesn’t sound very broke, does it?

Take away that $88 billion in interest because we don’t want to invest in government bonds? Now we have $869 billion in income for a SHORTFALL of $53 billion.

Plain and simple, we want that account to earn interest.

What Happens When There is a Shortfall?

When Social Security payments exceed total revenues, the shortfall comes from the Trust Fund. The Trustees estimate that total costs (benefit payments) will start to exceed total income (tax income and interest) in 2022. This is where the idea that Social Security is going broke comes from.

If that proves to be true then we will start to see the value of the trust fund decline as that shortfall is made up by spending down the balance of the trust fund.

Based on the estimates from the 2017 Trustees Report, we will deplete the Trust Fund by 2035. Nothing left.

What Happens When the Social Security Trust Fund is Depleted?

When we withdraw all of the money in the Trust Fund, Social Security benefit payments will not abruptly stop. Remember, Social Security is a pay-as-you-go system. There will still be workers who are paying their Social Security taxes and funding benefits for current retirees.

Clearly though, if benefits payments are higher than income (which is what caused the Trust Fund depletion in the first place) and there is no Trust Fund to draw from, then we have an issue.

In that case the current Social Security taxes would not be sufficient to cover all of the retiree benefits. The estimate from the 2017 Trustees Report is that current worker contributions will be sufficient to cover 75% of retiree benefits when we deplete the Trust Fund in 2035.

What Does All of This Mean?

To summarize:

  1. Social Security is a pay-as-you-go system.
  2. Surplus Social Security income goes into the Trust Fund.
  3. The Trust Fund invests in government bonds and earns interest.
  4. When expenses exceed income the difference is taken from the Trust Fund. We expect this to start in 2022. The Trust Fund is expected to be completely gone by 2035.
  5. In 2035 when we deplete the Trust Fund current Social Security taxes will cover 75% of promised benefits.

To be blunt, if nothing changes and the estimates are correct then you can expect to receive 75% of your Social Security benefit. While getting 75% of your benefit isn’t good, it’s a far cry from getting none of your benefits.

I’m not suggesting that you should be ok with that. I’m not suggesting you should NOT be ok with that. I am an educator and simply want to help you understand the facts as we know them now, free of hyperbole. The point of this article is to help you understand Social Security funding so that you know how it affects your retirement income plan.

This can also change. The rules can always change. In fact, that is exactly why the age at which you are eligible for a full benefit is increasing. Retirees born in 1960 or later can claim their full benefit when they turn 67.  Compare that with someone who is born in 1954 who can claim at 66.

There are a number of other ways that the Social Security funding issue can be improved. I’ll likely write about some of those in future articles.

Republished with the permission of BrandonRenfro.com.

3 thoughts on “What are the chances of relying on Social Security in retirement?”

  1. In your example of expenditures for 2016 of $922 billion vs total income of $957 billion, it sounds like we had a shortfall in social security collections for that year, which was filled by $88 billion in interest, correct?

    If I loan money to someone and get interest-only payments, with no hope of getting that principal back, that would be considered a bad loan. It sounds like that is what is happening to the Turst Fund. I am understanding this correctly?

  2. Is is Part of the income stream that we have built….different income plan for age 60-70 and SS part of the plan after 70 but really using SS as discretionary part of plan

    Think people should realize that having 40k in social security income is like having one million in assets(using the 4% withdrawal plan) for income purposes…

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