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Social Security Truth and Fiction Thumbnail

Social Security Truth and Fiction

Insights Investment Retirement Funding

We had a financial plan meeting recently with a client where they questioned whether Social Security payments would even be around when they eventually retired. We laughed, but quickly realized the client wasn’t laughing. The client was legitimately concerned about a plan that counted on Social Security payments to ensure their retirement. It’s an increasingly common statement we get from clients which stems from two factors. First, the financial media runs many misleading articles with attention grabbing headlines about social security “going broke.” Second, social security has increasingly been under attack, especially by Republicans. Elon Musk went so far as to call it “the biggest Ponzi Scheme of all time.” Given the increasing negative perceptions around the program and the importance it can play in many client’s financial plan, we felt it was necessary to separate fact from fiction. The good news is that we’re willing to bet the truth is better than most of our clients would expect.

Let’s start with the elephant in the corner: Is social security going broke? The short answer is no, at least not how people typically think of broke. When the media says social security will run out of money in the future, what they mean is that the current surplus ($2.8 trillion invested in Treasury bonds) will be exhausted. 

There are two important things to understand about this statement. First, that does not mean that people will stop receiving payments. If the current situation continues and no changes are made to the program, retirement benefits would be need cut by up to 20% (it varies based on key assumptions). A 20% reduction in income would be a big hit to many in retirement, but it’s not nearly as catastrophic as what the headlines lead people to believe. Why only a 20% discount? Because 80% or more of the current payments are supported by the program’s current income (i.e. payroll tax contributions to the program). In 2024, Social Security reported $1,351B of income. Most of that was social security payroll tax contributions ($1,233B) with the rest coming from income taxes on benefits ($51B) and interest income ($67B). However, Social Security outflows were higher, $1,392B. The vast majority were for benefit payments ($1,385B) with the remainder going to pay administrative expenses ($7B). The net outflow was therefore $41B for 2024. The excess comes out of the social security reserves. However, if the reserves weren’t there, you can see how the gap would be solved, right? You’d pay out $41B less in payments. However, you’d still have $1,233B of inflows from payroll taxes to distribute out to beneficiaries. So, the worst scenario seems to be a haircut to payments, not a full stop to payments. 

Second, these forecasts assume no changes are made to the program.  With some relatively minor changes to the program, the gap can be pushed out for the foreseeable future. There are many frameworks out there to fix social security, but the simple answer is that current taxes need to go up and benefits need to go down. There are ways to do this without huge financial impact to retirees and current income taxpayers. As an example, here are the key elements of a plan from the Brookings Institute that would keep social security solvent for the next 75 years. You can find many others with a quick google search. Most of the changes proposed are not dramatic and many are focused on taxing high earners only. For example, the Brookings Institute proposal calls for an increase in payroll taxes for social security. That might sound bad, but their proposal calls for a 0.2% increase from 12.4% to 12.6%. I doubt most people would even notice that in their paycheck (even though my Mom, an accountant, definitely would). 

Some other examples of changes to make to the program: 

  • Increase the taxable income ceiling: Currently, social security taxes phase out after $168,600. If that threshold was increased, the program would collect more tax revenue from high earners.

  •  Change the rules for pass-through payroll taxes: Social security taxes are only collected on employment earnings, but many people earn money through other forms of income that is passed through as investment income.

  • Increase the payroll tax: The current payroll tax for social security is 12.4% on wages. The Brookings proposal would increase that tax to 12.6% only.  

  •  Increase the retirement age for high earners: The Brookings proposal would slowly increase the retirement age to 70 for the top earners.
     
  •  Increase the number of working years used to calculate earnings: The payment is currently done using the highest 35 years of employment history. Adjusting that calculation to use the highest 40 years of employment history would subtly bring down retirement payments on average.

  •  Tax all social security benefits: Tax the full benefits for retirees with $100k or more of taxable income. 

What does this mean for our clients? Hopefully this information helps reduce some of the fears over social security going broke. A realistic worst case scenario seems to be a 20% reduction in expected payments. However, we feel there are reasonable reforms that would extend the full life of social security through some combinations of a) small tax increases, b) reduction in payments to high earners, and c) elimination of select fringe benefits. We would hope that was a cocktail that both parties could support to fix such an important program. Given the current state of DC however, we won’t be holding our breath for it anytime soon.

Best,
Chris

Chris Roth
CIO
5T Wealth, LLC
Main (707) 224-1340
595 Coombs St
Napa, CA 94559

Disclosure and Disclaimer - Updated last on March 20, 2024 by Paul Krsek: 

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