How They Will Likely Fix Social Security by Scott Stolz, CFP, RICP (week 29)

 

About 35 years ago I began regularly asking audiences at my speaking engagements whether or not they expected to receive Social Security benefits when they retired.  Even back then, I would see about 1/3 of the crowd raise their hand to vote “no”.  But I noticed something interesting when conducting this very informal and unscientific poll.  Virtually every raised hand belonged to someone below the age of 50.  The older people in the audience seemed to consistently believe they were going to squeeze by before Social Security ran out of money.  Interestingly, these percentages have not changed much over time.  According to a 2023 survey conducted by the Nationwide Retirement Institute® (of Nationwide Life Insurance Co.), more than 40% of those surveyed below the age of 42 believe they will never receive Social Security Benefits.  That compares to just 12% for those 59 years old or older.¹   

 

However, three of four over the age 50 fear that Social Security will run out of money during their lifetime.  When you consider that 50% of all social security recipients rely on social security to make up at least ½ of their total retirement income, it’s understandable that so many are concerned about the financial health of Social Security.  Additionally, 1 in 5 (21%) adults age 50+ rely on Social Security as their sole source of retirement income.   As tempting as it may be to criticize Social Security, there’s no denying that it is an essential part of the financial well being for millions of Americans.  And that is precisely why I don’t worry about it.  Congress knows that the topic of Social Security reform is a hot topic, so they will likely continue to kick this can down the road for as long as they can, but eventually they will fix it.  They simply have no choice.  Too many voters count on it.  If benefits get cut, people will be voted out of office.  The only real question is how will they fix it?

Following is a list of the most common solutions offered:

1.      Raise the level of Social Security taxes on either employees and/or the employer

2.      Reduce benefits to some or all recipients

3.      Increase the age at which people can begin collecting benefits

4.      Reduce or eliminate the annual cost of living increases (COLA) to existing and future benefits

5.      Increase taxes on benefits (yes, Social Security benefits are taxable)

6.      Increase the annual income cap so that higher wage earners pay more Social Security taxes each year

7.      Increase the rate of return earned by the Social Security trust fund (i.e., investing some of the existing surplus in equities)

I would argue that increasing the retirement age, reducing the COLA increases and increasing taxes on benefits (#3-#5 above) are each just subtle ways to reduce benefits, while increasing the annual income cap is really just a subtle way to increase Social Security taxes.  Therefore, one could argue that there are only 3 possible solutions.

After looking into my crystal ball, here are my predictions:

·       They will not increase the Social Security taxes, which is now 12.4% (6.2% to the employee and 6.2% to the employer).   According to the Nationwide survey, less than 1 in 4 people support this solution.  Quite frankly, I’m surprised it’s even that high.  In addition, voters would see increasing taxes on benefits as just a way to cut benefits, so this seems unlikely as well.

·       They will not reduce benefits across the board.  That would likely lead to riots in the streets.  In addition, most people rightfully believe that since they paid into the system during their lifetime, any cut in benefits is really just the government stealing their money

·       They will likely look at finding a way to reduce the COLA increases because they could then say they didn’t “cut” benefits (even though this is a cut), but this would not provide near enough extra savings to solve the problem.

·       Back in 2005, President George Bush proposed allowing workers to invest a portion of their Social Security taxes into equities, but that proved to be too controversial.  There’s no doubt that over the long run, such an option would provide more retirement income, but had that been approved just before the 2007-09 stock market crash, it likely would have been viewed as a terrible solution.

That leaves us just 2 likely choices – increasing the retirement age and raising or eliminating the annual income cap for higher wage individuals.  Back in 1983 Congress phased in an increase in the full retirement age from 65 to 67.  If you were born in 1960 or later (like me), you have to wait until age 67 to receive your full retirement benefit from Social Security.  You can start getting benefits at the age of 62, but the benefits are greatly reduced.  Anyone born prior to 1960 has a full retirement age of between 65 and 67. This change was meant to permanently fix the system.  It obviously did not.  I could easily see Congress doing this again.  After all, we are living longer.  However, many people can’t work even until 67.  Making them wait even longer will not be popular.  And it likely won’t fully fix the problem.

So that brings us to raising or eliminating the income cap.  Let me first explain what this is.  Each year, based on guidelines determined by Congress, the Social Security Administration sets a cap up to which the 6.2% Social Security taxes are paid.  In 2026, that cap is $184,500.  Anyone making more than that pays the 6.2% FICA tax only on $184,500.  Any earnings above that amount are not taxed.  I should note that there is no cap on the 1.45% Medicare tax portion of FICA. Every taxpayer pays that on 100% of earnings. The Nationwide survey sites this as the most popular solution to the problem with almost 50% of those surveyed stating it’s a good idea.  And why not?  Why should high income earners get such a break?  Isn’t this just another tax cut for the wealthy?  And in fact, this solution is often positioned this way.  On the surface, it just seems so unfair to so many that are struggling financially – especially those that rely so heavily on Social Security benefits.  And that is why I’m convinced that this will be part of the solution.

However, before you jump on this bandwagon, let me offer you a different perspective.  The fairness of Social Security is really about how much you receive relative to what you paid in.  Someone might not be taxed on all of their income, but if that person only gets Social Security benefits based on what income is subject to FICA taxes, then he or she is not benefiting at all.  In fact, you might be surprised to learn that when looked at this way, higher income people actually already subsidize lower income people.  The formula used to calculate your Social Security benefits is designed so that the more you earn, the less you get relative to what you pay into the system.  I’m going to skip the actual calculations and try and just give a simple example.  Someone that has made $50,000 per year over their lifetime, will get an annual Social Security benefit of about $24,170 or almost 50% of their annual income.  Contrast that to the person that has earned at least the capped amount each year.  That person will get a benefit of about $49,000 per year, or roughly 28% of the income on which they were taxed.  Yes, they will get about twice as much money each year, but they also paid in 3.5 times as much in taxes.

My point is not to be critical of how the benefits are calculated.  I have no issues with higher income earners subsidizing lower income earners.  And maybe further increasing this subsidy should be part of the solution.  My point is that it would be inaccurate to call the current system unfair simply because the high-income worker does not have to pay Social Security taxes on earnings above $184,500.  Yet, if this becomes part of the system fix, I can guarantee you that it will be sold to taxpayers as a way to not only fix the system but make it more “fair” to everyone. 

 

¹ Majority of U.S. adults believe Social Security benefits will dry up in their lifetime | PlanSponsor