Social Security Looks Pretty Good. But Medicare’s Another Story.
On an annual basis, the Trustees of the US Social Security and Medicare trust funds provide their report on the current and projected financial status of these programs. Gail Buckner, CFP®, examines the findings in the Trustees’ 2016 report and clears up some misconceptions about the state of Social Security in the United States.
You’d never guess by the scary headlines containing terms such as “crisis” and “future uncertain” that the latest annual report issued by the US Social Security Trustees showed a slight improvement in the program’s financial outlook. The 75-year actuarial deficit—a way to put a number on the size of Social Security’s long-term funding shortfall—actually declined from 2.68% to 2.66%.1 That’s not because of a spike in the baby-boomer death rate. Rather, the change is attributed to “recently enacted legislation, updated demographic and economic data and improved methodologies.”2 These include the phase-out of two claiming strategies, a policy decision contained in the Bipartisan Budget Act of 2015 (Budget Act) passed last November.
The thing to keep in mind is that there’s no need to panic. There are two separate trust funds from which Social Security benefits are drawn: the Disability Income (DI) Trust Fund for disability benefits and the Retirement Trust Fund for retirement benefits. Instead of hitting a shortfall this year, Social Security now projects it can continue to fully pay disability benefits until the third quarter of 2023. Again, the Budget Act is the reason: Congress approved temporarily re-allocating a larger portion of the payroll tax to the DI Trust Fund, thereby reducing the amount going into the Retirement Trust Fund. If no additional changes are made before the end of 2023, starting in 2024, the DI Trust Fund is expected to have sufficient assets to cover 89 cents on the dollar.
The Retirement Trust Fund isn’t projected to drop below 100% coverage of benefits until sometime in 2034. After that, the surplus in both Social Security trust funds is projected to be “depleted.” However, that does not mean that either disability or retirement benefits will cease. In fact, the payroll tax that Social Security will continue to receive from current workers will be sufficient to pay 79% of scheduled benefits.
In other words, even if nothing is done to address this issue, in 17 years, Social Security will still be collecting almost 80% of the money it needs to cover expenses and benefits.
To sum it up:
- Social Security is far from “broke” or “bankrupt.”
- We have nearly two decades to address the projected shortfall!
A Matter of Demographics
Social Security is facing a long-term funding issue—albeit a relatively small one at this point—not because of mismanagement or waste, but because of something far more mundane: demographics. Two factors in particular share the starring roles.
The first is that we are all living longer. In 1930, average life expectancy at birth was just 58 for men and 62 for women.3 As of 2014, it was more than 76 years for men and 81 for women, a gain of nearly two decades.4 As life expectancy continues to improve, Social Security will have to pay benefits to more individuals for more years.
The second factor in the demographic equation is that generations coming behind the baby boomers have fewer members.
During the post-war years of 1946–1964, the US birth rate shot up to 3.3%, meaning that, on average, every woman of child-bearing age had three children. That effectively meant that there were three children eventually in the workforce contributing to Social Security and covering mom and dad’s benefits—a very favorable ratio.
Starting in 1965, the US birth rate began to fall to less than three births per woman, which changed the age distribution of the population. That means we have a higher dependency ratio—there are fewer younger people able to support prior generations. Moreover, even after the last baby boomer heads off to rock ‘n’ roll heaven, there will still be roughly two workers supporting two retirees because today’s teenagers are expected to live even longer than their grandparents did.
Social Security’s long-term financing challenge has been known for decades. We know when people born in any given year become eligible for Social Security. However, members of Congress are no different than the rest of us; if a problem isn’t immediately staring you in the face, you tend to put it aside and turn your attention to other, more pressing concerns. However, like the small leak in your roof, if you ignore the problem too long, there’s a good chance it will get bigger and more expensive to fix.
The good news is that at this point, “fixing” Social Security is not that expensive. Recall that the aforementioned “actuarial deficit” is 2.66%. Add this to the current Social Security tax rate of 12.4%, and get 15.0% (rounding down). The 2016 Trustees Report tells us that if we increased the payroll tax from 12.4% to 15%, we would solve the funding shortfall for Social Security for the next 75 years.
This is not to suggest that this is what will happen; taxes are unpopular, after all. A more likely scenario is that a number of assumptions and factors used in Social Security’s calculations will be “tweaked.” This might mean some individuals will get a slightly smaller benefit, or that the full retirement age will be increased to 68. It’s probable that a number of different things will be adjusted slightly.
But, for a moment, consider what would be involved if, in fact, the payroll tax were the only thing changed. Since employers and employees split the 12.4%, each side currently contributes 6.2%. If both sides also split the increase in the actuarial deficit, it would amount to an additional 1.3% for the Social Security program. In dollar terms, this means that if working Americans contributed $13 more for every $1,000 they earn, it would solve Social Security’s funding problem for the next 75 years.
Personally, I have not come across a single individual who is not willing to do this. That’s how important Social Security is to Americans. Most are willing to pay a little more today to ensure that they—and their families—can count on it in their later years.
COLA Hit by Brexit?
It’s worth noting that in making the latest projections, Social Security assumes that retirees will get a very tiny cost-of-living adjustment (COLA) next year: 0.2%.5 That’s far below average, but better than no increase at all, which is what happened this year.
However, when determining the amount of inflation that has occurred from year to year, Social Security compares third-quarter prices from the previous and current years. In 2015, oil prices (a significant component of the inflation calculation) fell from July through September. That’s what nixed an increase in Social Security benefits this year. Guess what just happened when the United Kingdom voted to exit the European Union? Oil prices plummeted again. So, in addition to all of their other ramifications, the effects of the UK referendum also may travel across the Atlantic Ocean and help determine whether American retirees get even a small boost in their Social Security in 2017.
Medicare costs do not take the price of oil into account. The cost of health care seems to go in only one direction—up. As a result, the Trustees estimate that the Medicare Trust Fund “will be depleted” in 2028, two years earlier than projected last year and six years sooner than the combined Social Security Trust Funds.6
This means that we could see the same situation we had last fall: no increase in Social Security benefits, but significantly higher Medicare premiums. Since lower-income seniors are excused from absorbing this cost, those with higher incomes bear the brunt of it. The result? Their larger 2017 premiums will be deducted from monthly Social Security checks that are likely to be only a tiny bit larger or the same amount as this year.
Gail Buckner’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the United States, which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
This information is intended for US residents only.
Important Legal Information
This material is being provided for general informational and educational purposes only and should not be construed as investment, tax, accounting, or legal advice, or as a solicitation to buy or sell any specific securities product, or used as the primary or final determinant of the best strategy on how and when to claim Social Security benefits. It is believed to be reliable; Franklin Templeton Investments (FTI), however, makes no representations or warranties as to its accuracy, completeness or timeliness. It does not provide a complete analysis of every material fact regarding the Social Security program. The hypothetical scenarios are estimates, based on assumptions, and designed to provide a general understanding of the impact of different Social Security benefit claiming strategies. Helpful information can be found at the Social Security Administration’s (SSA’s) website: http://www.ssa.gov. FTI accepts no responsibility for content on the SSA’s website or other third-party websites. Social Security benefits claiming decisions can be complex and depend on various personal factors besides your age or retirement date, including, but not limited to, your: personal circumstances, needs and individual goals; legal and financial considerations; and tax laws, consequences and status, some or all of which can change frequently. We strongly advise you to consult with the appropriate financial, legal, accounting, tax or other applicable advisors about your specific circumstances and individual goals.
1 Source: The 2016 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Insurance Disability Insurance Trust Funds. www.ssa.gov/oact/trsum/
2 Source: A Summary of the 2016 Annual Reports, Social Security and Medicare Boards of Trustees.
3 Source: US Social Security Administration website, “Social Security History” www.ssa.gov
4 Source: The 2016 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Insurance Disability Insurance Trust Funds. www.ssa.gov/oact/trsum/