Social Security is primarily (but not solely) funded by the payroll taxes which it collects on all employment income. There is a 5.3% payroll tax on the income of employees, plus 5.3% for employers. Self-employed individuals have the privilege of paying 10.6%; that is, the usual portion for both the employee and employer.
The first alarm bells of Social Security deficits were sounded in 2011. This was the year that Congress enacted a Social Security payroll tax holiday as a form of temporary economic stimulus. For both 2011 and 2012 Congress temporarily reduced the employee portion of payroll taxes from 5.3% to 3.6%. This caused a dramatic drop in program revenues and also muddied the Social Security cash flow picture. The program ran significant deficits and required federal reimbursements of $88 and $98 billion in those two years in order to backstop the lost revenues.
Starting in 2013, however, employee tax rates returned to the normal 5.3% and federal reimbursements went away. While the 2013 numbers are still not available, actuarial estimates from the 2013 Social Security Trustees Report projected that, in 2013, payroll tax and income tax receipts would total about $642 billion and projected benefit payments would total $675 billion. This difference of $33 billion is the remaining ‘cash flow’ deficit to which some people refer.
This critique, however, conveniently ignores another important income source: interest income. The Social Security OASI Trust Fund, now valued at roughly $2.7 trillion, is fully invested in US Treasury securities. The projected 2013 interest payments on this investment are approximately $98 billion. Add this into the tax receipts and the program remains snugly in the black.
Shockingly, in light of the continuing narrative of deficit spending, Social Security OASI annual financial operations is actually projected to remain in the black until 2022 based on intermediate projections by the Social Security Administration! Furthermore, the OASI Trust Fund is even expected to grow to as much as $3.0 trillion in the early 2020s.
At this point, demographics finally do kick in. The amount of benefits being paid out will outstrip both tax revenues and the interest payments. There really will be an annual deficit by any definition and the trust fund will begin to be drawn down.
There is no sugarcoating the fact that the huge baby boomer demographic will likely fully deplete the trust fund (as planned) sometime in the mid-2030s and stress the system thereafter leading to benefit reductions of approximately 25% if no changes are made. A number of workable proposals to re-balance the system have been made and seem to only require the political will to get it done.
In the meantime you can help your clients understand that while challenges exist, the Social Security system is not bleeding red ink, projects full benefits for another 20 years and most observers expect necessary adjustments to the system will be made to stabilize benefits thereafter.
Paul Norr is a financial planner in Thousand Oaks, Calif., and writes about planning and retirement. His website is www.paulnorr.com.