The 2019 Social Security Trustees report is out. That means we know how Social Security performed financially in 2018, and we also have the latest projections about the financial future of the program.
At first glance, the numbers might look good. Social Security brought in more money than it spent and is sitting on a massive $2.9 trillion in reserves. At the same time, we also learned that Social Security will be completely out of money within 16 years. Since this may seem like a massive contradiction, here's a rundown of how Social Security's financial condition looks now and what is expected to go wrong over the next decade and a half.
Image source: Getty Images.
Social Security's cash flow in 2018 was strong
On the surface, Social Security's financial situation looks solid. In 2018, Social Security took in a total of $1.003 trillion. This consisted of:
- $885.1 billion in payroll taxes from employees and employers.
- $83.3 billion of interest income on reserves.
- $35 billion from taxes collected on benefits.
Meanwhile, the program's expenditures were almost exactly $1 trillion. The vast majority ($988.6 billion) was in the form of benefit payments.
Subtracting Social Security's expenses from its income shows that the program ran a surplus of $3 billion for the year. This follows a surplus in 2017 and other recent years.
Furthermore, you'll notice that a significant chunk of Social Security's income came from interest earned on its reserves. As of the end of 2018, Social Security had a total of $2.89 trillion in reserves. This money is invested in government securities that pay interest, and currently translates to nearly three years of operating expenses for the Social Security program.
The problem with Social Security
After reading that last section, you might be surprised to learn that the same trustees' report that revealed those figures also projects that Social Security's reserves will be completely exhausted by 2035. So, what is going to happen over the next 16 years that will cause Social Security to spend every dime it brings in, plus nearly $3 trillion?
The answer is that the massive Baby Boomer generation is gradually starting to reach retirement age. Not only will this increase the number of older Americans drawing retirement benefits from Social Security, but it will also cause more people to leave the workforce than are entering, leading to fewer Americans paying Social Security payroll taxes.
One good statistic that sums up the problem well is the number of covered workers (people paying in to Social Security) per beneficiary. Throughout most of the past few decades, this ratio has been well over three. In other words, more than three people were paying into the system for every person drawing benefits. In 2018, this ratio was 2.8, which, as we can see, is just enough for the program to run a surplus.
However, this ratio is forecast to steadily fall. By 2035, when Social Security is forecast to run out of money, the baby boomers will have mostly retired and only 2.2 workers will be paying in for each beneficiary. This implies that there will be about 21% less payroll tax coming in. Obviously, if the program is barely in the black right now, this won't be sustainable.
Because of this trend, Social Security's financial condition is expected to get worse, and fast. In fact, 2019 is the last projected surplus for the foreseeable future. Deficits are forecast to begin in 2020 and while these should be relatively small deficits at first, they'll likely get big quickly.
When Social Security runs a deficit, funds from the program's reserves are used to make up the difference. By 2028, Social Security's reserves are expected to decrease to about $2.15 trillion, and thanks to skyrocketing program costs, are expected to be completely exhausted by 2035.
To be perfectly clear, if Social Security's reserves run out, benefits wouldn't simply stop being paid. There would still be incoming revenue from payroll taxes and taxation of benefits that would be enough to cover 80% of scheduled benefits.
In short, based on the latest projections, starting in 2035, Social Security beneficiaries can expect a benefit reduction of approximately 20%.
Can Social Security be fixed?
Social Security can be fixed, but the longer Congress waits to act, the tougher it'll be.
Potential fixes include raising the Social Security payroll tax rate for all employees and employers. Based on the trustees' report, an increase of about 2% (from 6.2% to 8.2%) up to the taxable wage cap on both employers and employees would solve the problem.
Alternatively, the annual maximum taxable earnings cap could be raised, or even eliminated. Or there could be some sort of benefit reduction like raising the full retirement age or lowering benefits for higher-income retirees. Most likely, an eventual fix would consist of a combination of a few different options.
Whatever the eventual fix is, it'll be far easier to implement if it happens earlier -- such as phasing in a payroll tax increase over the next 16 years as opposed to simply raising it all at once.
The bottom line is that Social Security most definitely can be fixed. Whether it will be fixed or not, as well as the timing and method of any fix, remains anyone's guess at this point.
More From The Motley Fool
- 10 Best Stocks to Buy Today
- The $16,728 Social Security Bonus You Cannot Afford to Miss
- 20 of the Top Stocks to Buy (Including the Two Every Investor Should Own)
- What Is an ETF?
- 5 Recession-Proof Stocks
- How to Beat the Market
The Motley Fool has a disclosure policy.