My Aunt Julia didn’t pay much attention to politics. The only political statement I ever heard her say was “Don’t touch my Social!” She said it loud and she said it often.
Social Security provides retirement and survivor benefits to 46 million Americans. In 2010 it was the only source of income for 20% of retirees and provided more than half of total income for 50% of retired couples and 75% of non-married retirees.
Congress passed the Social Security Act of 1935 to create a safety net to prevent the financial devastation experienced by many elderly Americans during the Great Depression. The American public was divided on the objectives for the proposed program. Should benefits be based on a worker’s contributions or should the program provide equal benefits for all? Eventually, Social Security combined both features. Benefits are proportional to a worker’s pre-retirement earnings but replace a higher percentage of earnings for lower wage earners.
Social Security is funded primarily through a 12.4% FICA payroll tax. Workers and employers each pay 6.2%. If you’re self-employed, you pay both portions. For the past several decades, FICA tax revenues have exceeded benefit payments and the surplus has been invested in interest-bearing, special issue U.S. Treasury securities. This was done in anticipation of the increase in payments that would occur when baby boomers started receiving benefits.
Social Security benefits are funded by pay-as-you-go financing, meaning that current benefits are paid from current tax revenue. Consequently, unlike traditional pension plans, its ability to pay benefits is not affected by the ups and downs of financial markets.
Each year, the Social Security’s board of trustees presents a report to Congress containing an actuarial look at Social Security’s financial health and its ability to pay promised benefits for the next 75 years. This gives Congress an early warning of potential problems and time to consider appropriate solutions. Changes can be phased in gradually, giving those most affected by the changes time to plan accordingly. The last few Trustees’ reports show that Social Security’s finances have deteriorated in recent years; creating doubts about the dependability of benefits and causing undue alarm among many retirees.
Although Social Security has paid out more in benefits than it has received in FICA taxes for the last three years, other sources of revenue made up the shortfall. The U.S. Treasury securities held in the Social Security Trust Fund generate steady interest payments. Some Social Security recipients pay taxes on their benefits which are credited to the trust fund.
In 2012, the trust fund contained $2.7 trillion in U.S. Treasury securities and it is expected to grow to over $3 trillion by 2020. These are the world’s safest bonds despite what some talking heads might be shouting. Beginning in 2021 the trust fund will be paying out more in benefits than it receives from all revenue sources. It will be depleted by 2033 — if nothing is done to increase revenue or modify benefits. Should this occur, FICA tax revenues will be sufficient to pay only 75% of promised benefits after 2033. This is the worst case scenario.
The idea that workers should be allowed to take a portion of their FICA taxes and invest them is folly. Any tax revenues diverted to private accounts would increase Social Security’s actuarial deficit. It has become an urban legend that FICA taxes are an investment that should guarantee a nice rate of return. Social Security is not an investment; it is an extensive insurance policy that pays benefits when an insured event occurs — disability, retirement or death.
FICA taxes are insurance premiums that allow you to qualify for benefits when an insured event occurs. Any observer of our dysfunctional defined contribution retirement system, who believes that workers would be better off depending less on Social Security and more on their investing prowess, is delusional.
Another silly notion is that Social Security is a Ponzi scheme. This is nonsense. A Ponzi scheme is a deception, a lie. The money is not invested as promised but stolen from its victims. Social Security is open and transparent and publishes an annual report detailing its financial health. It has paid benefits on a timely basis for 78 years despite depression, recession, war, inflation and deflation. Frankly, Social Security is in better financial shape than most of its beneficiaries.
Just like rock ‘n’ roll, Social Security is here to stay. It will play an important part in every baby boomer’s retirement. It is politically inevitable that the post 2033 funding shortfall will be fixed by tweaking revenue and benefits. Most benefit cuts will be borne by younger workers, not people who are receiving, or soon to receive, benefits.
If you are in or near retirement, don’t minimize the importance or the reliability of your Social Security benefits in your retirement planning.
[by George Sisti, writing for MARKETWATCH]
As always, posted for your edification and enlightenment by
NORM ‘n’ AL, Minneapolis