Social Security

Executive Summary

Historically, Social Security tax income was greater than the benefits paid out.  Instead of saving and investing the surplus, the government 'borrowed' it from the Social Security Trust Fund and spent it all through the General Fund.  There is technically $2 trillion in the Trust... but it's all in the form of government bonds, i.e. it's government debt we owe ourselves.  It now shows up as a significant contributor to the National Debt, under the unhelpful heading of 'intragovernmental transfers':

Even more insulting, these government bonds pay interest... so we owe interest on the debt as well.  We owe interest to ourselves.

Going forward, as the Baby Boomers retire and the Social Security tax income is not sufficient to pay the promised benefits, there is no money saved to cover the difference.  We will only be able to afford to pay out at the same rate the Social Security tax brings money in, unless taxes are raised or services are cut elsewhere.  This is a rather depressing state of affairs.

Your Social Security Benefits

The United States' Social Security system is central to recent discussions on the federal budget.  In the Fiscal Year 2012 budget, Social Security represented $773 billion of $3.793 trillion (20.4%) in total federal expenditures (1).  Administrative costs ($6.4 billion) are currently less than 1% of Social Security expenditures (2).

Your Social Security benefits are calculated with a formula that takes into account your Average Indexed Yearly Income (AIYE), which is an inflation-adjusted average of the earnings in your 35 highest-earning years (2).  The marginal rate of benefits accrual decreases at higher incomes, and monthly Social Security benefits are capped at $2500:

The average benefit for a US retiree in 2012 was $1,229 (3).  After paying the average Medicare premium of $304, that leaves $925 to help pay for... everything else.  If your employer does not offer a pension, then your personal savings have to make up the difference.

The retirement age to receive full benefits is currently 66, and will be increasing through 2022 to 67.  You may begin collecting benefits at 62, but the amount of your benefits are reduced by a certain percentage for life (4):

Social Security and Medicare are financed by payroll taxes, which currently make up 31.4% of the federal government's income (1).  Payroll taxes are a capped flat tax split evenly between employers and employees, which in 2013 add up to 15.3% of your annual wage up to $113,700 (5).  Payroll taxes are automatically withheld from an employee's paycheck, and are paid in addition to income taxes.  The Tax Relief Act of 2010 reduced the employee portion of Social Security taxes from 6.2% to 4.2% for 2011 and 2012, but the tax has reverted back to 6.2% for 2013 (6).

You can check your Social Security contributions and benefit status online using your Social Security Number (7).  If you're a student on a fellowship or you have other income that isn't charged payroll taxes, this income won't appear in your account and isn't counted when calculating your AIYE and monthly benefits payout.  In essence: if you're not paying in, you're not building up benefits eligibility.

Financial State of the System

As mentioned above, Social Security payouts are currently 20.3% of federal expenditures and payroll taxes are currently 31.4% of federal income (1).  Unfortunately, expenditures ($3.793 trillion) exceed income ($2.469 trillion) by $1.324 trillion (53%).  Payroll taxes also cover Medicare and Medicaid, so the numbers do not add up:

+ $775 billion     Payroll Taxes
-  $773 billion     Social Security
-  $733 billion     Medicare + Medicaid
= - $731 billion

Breaking down the payroll taxes:

  • 15.3% total payroll tax = 12.4% Social Security tax + 2.9% Medicare tax
  • Social Security tax = 81% of payroll taxes
  • Medicare tax = 19% of payroll taxes
Payroll tax income to Social Security: $627.75 billion
Social Security payouts: $773 billion
Social Security shortfall: $142.25 billion — 18.4% underfunded 

Several changes could help close the gap:
  1. Raising Social Security taxes
  2. Raising or removing the so-called 'Social Security Wage Base' limit
    (currently, only income up to $113,700 is charged Social Security taxes)
  3. Lowering the Social Security monthly benefits ceiling
    (currently $2513 per month, though you would need an AIYE of $122,000 to get this much)
  4. Increasing the Full Retirement Age
    (currently age 66, with reduced benefits available starting at age 62)

Where Is That $1.3 Trillion?

Over the history of Social Security, the program has collected $8.7 trillion and paid out $7.4 trillion (8).  The remaining $1.3 trillion is held in the Social Security Trust Fund, where it is invested in special US Treasury notes with a guaranteed interest rate.  Therefore: the value in this trust fund is held in a sort of US government bond.  The Trust Fund buys these bonds from the Treasury, so the payroll taxes actually go... into the General Fund.  These special-issue intragovernmental bonds have been criticized as being nothing more than "IOUs" from one account to another (9).  The payroll tax income itself is spent out of the General Fund to finance... whatever Congress decides to spend it on.

From Wikipedia:

When program revenues exceed payments (i.e., the program is in surplus) the extra funds are borrowed and used by the government for other purposes, but a legal obligation to program recipients is created to the extent this occurs. These surpluses add to the Trust Fund.

From the Office of Management and Budget, in 1999:

These [trust fund] balances are available to finance future benefit payments and other trust fund expenditures--but only in a bookkeeping sense. These funds are not set up to be pension funds, like the funds of private pension plans. They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury, that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures.

Therefore, the Trust Fund is simply an accounting tool, a record of how much money the federal government has 'borrowed' from Social Security.  When the value in that fund is actually required to pay benefits - when Social Security taxes can't pay all of the benefits owed - then the government has to come up with that money by raising taxes or cutting services elsewhere.

So, about those individual retirement savings plans...

Take matters into your own hands and check out my guide to opening your own individual retirement savings plan.

(1) http://useconomy.about.com/od/usfederalbudget/p/US-Government-Federal-Budget-FY2012-Summary.htm
(2) http://www.socialsecurity.gov/policy/docs/statcomps/supplement/2012/supplement12.pdf
(3) http://www.dailyfinance.com/2011/12/20/what-social-security-gets-you-a-minimum-wage-lifestyle/
(4) http://www.ssa.gov/OP_Home/handbook/handbook.07/handbook-0724.html
(5) http://taxes.about.com/od/payroll/qt/payroll_basics.htm
(6) http://taxes.about.com/b/2010/12/20/the-tax-relief-act-of-2010-income-tax-provisions.htm
(7) http://www.ssa.gov/myaccount/
(8) http://en.wikipedia.org/wiki/Social_Security_Trust_Fund
(8) http://www.heritage.org/research/reports/2004/09/misleading-the-public-how-the-social-security-trust-fund-really-works