The goal of the Social Security program is to provide retirement and disability benefits to workers and their families. Workers pay into the system, the government holds onto the money, and the money earns interest. When workers reach eligibility, the government returns money to them.
However, unlike a personal retirement plan, such as a 401(k) or an IRA, where the money invested belongs to the worker, Social Security is more like an investment pool.
A common misconception about Social Security is that it will run out, which isn’t true. Revenue collected from taxes covers the benefits that are paid out. However, without changes, the Social Security system is expected to exhaust its existing reserves and workers may not receive their entire benefits.
According to a 2020 projection from the Social Security Administration (SSA), workers who reach retirement age after 2034 are projected to receive 76% of scheduled benefits.
The Current Problem With Social Security
Because benefit payouts are tied to the SSA’s reserve balance, it begs a question for many working Americans—what happens when that balance hits zero? The SSA itself acknowledges that benefits will likely only be available in full until 2034. That’s just 14 years away.
Reasons for the depletion of fund reserves are attributed to a number of challenges, including a rise in program costs. Cost-of-living adjustments, or COLA, have been steadily increasing. Life expectancy for Americans has grown longer, while the number of workers hasn’t kept pace with the number of retirees.
The government estimates that funds post-depletion will be enough to pay out at 76% , unless Congress makes changes to the program.
How to the Solve Social Security Problem
Lawmakers, financial experts, and retirement advocates are starting to float ideas for how to save the program. To date, the two ideas that have been floated include raising the Social Security tax or reducing the benefit—two options that are likely to be unpopular with both workers and retirees.
There are many details on how to implement those two ideas. Some business publications say that the deficit could be eliminated with a combination of both that aggregate to 2.84% of payroll—that equals less than 3 cents for each dollar earned, and it would be split by workers and employers.
Another proposed fix, called the Social Security 2100 Act , would make a number of changes to the current system, such as changing the formula for COLA to use a Consumer Price Index for the Elderly (versus its current price index for wage earners).
It would also involve setting the new minimum benefit at 25% above the poverty line. Advocates say the result would be like getting a 2% raise of the average benefit.
How Social Security Works
The American Association for Retired Persons (AARP) describes Social Security as a “pay-as-you-go” system , meaning that the contributions made by workers today are used to pay the benefits of retirees. When today’s workers retire, they’ll receive benefits based on what the next generation contributes.
Any money that’s left over after all the benefits are paid out go into one of two trust funds.
How Americans Pay and Get Paid Social Security
The amount each individual worker contributes to Social Security depends on their income. Employees who work for a traditional employer split the Social Security tax payment with their employer at 6.2% each , and self-employed workers are responsible for the entire 12.4%.
The income cap for 2020 is $137,700, and as of June 2019 the SSA reported that around 177 million people were working and paying Social Security taxes.
As employees contribute to the tax, they earn Social Security “credits”—one for every $1,410 in earnings in 2020 with a max of four per year.
What Is the Age Eligibility for Social Security?
Those employees become eligible for benefits when they reach 40 credits, which equals roughly 10 years, or full retirement age. For Americans born in 1960 or later, that’s 67 years old .
Getting the most out of Social Security benefits becomes a numbers game as workers get close to retirement age, because workers are technically eligible at age 62. But for each month previous to full retirement age that someone starts drawing benefits, they’re reduced by one-half of one percent.
According to the SSA , that means if a worker’s full retirement age is 66 and 8 months and they start drawing Social Security at age 62, they’ll only get around 71.7% of their full benefit.
The benefits stop increasing at age 70, and the AARP reports that workers who are able to wait that long get the most return—full benefit plus delayed retirement credits—but individual decisions should be made on a number of factors, including employment outlook and health.
The Two Social Security Trust Funds
After all the contributions have been paid in and benefits paid out, any remaining funds are divvied up between two trust funds , where they earn interest in government-guaranteed Treasury bonds.
As of the 2020 annual report from the SSA, assets reserves at the end of 2019 were at around $2.9 trillion , divided up between the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund.
The larger of the two funds, the OASI , pays benefits to retired workers, their surviving spouses and eligible children, and covers administrative and other expenses. It’s the largest fund that takes care of retirees who don’t face special circumstances, and deposits are made daily. It’s been around since 1940.
The smaller DI Trust Fund handles monthly benefit payments to disabled workers and their spouses and children until they’re eligible for full benefits through the OASI.
Even though both funds are a part of the overall federal budget, they’re handled separately and the SSA isn’t allowed to pay out more than what’s in the trust fund.
History of Early Social Security
The need to secure a financial future for ourselves and our loved ones isn’t new—or uniquely American. Across the pond, the English passed a series of “Poor Laws” around 1600 intended to ensure that the state provided for the welfare of its poorest citizens.
Americans were quick to embrace the idea that the country should take care of its people, but at first it wasn’t society at large. In 1862, for example, a post Civil War-era program offered pensions to disabled Civil War soldiers, and widows and children of the deceased.
Around the late 1800s, some private companies were starting to offer pension plans too. The first company to offer a real pension plan was the Alfred Dolge Company, which made pianos and organs. They took 1% of an employee’s salary and put it into a pension plan, and then added 6% interest per year.
In 1935, President Franklin D. Roosevelt signed into law the Social Security Act . The government then started collecting Social Security taxes two years later. Then on January 31, 1940, the first monthly retirement check of $22.54 was issued to Ida May Fuller in Ludlow, Vermont.
This Isn’t the First Social Security Shortfall
The retirement en masse of America’s Baby Boomers and parallel decline in birth rate is taking the blame for Social Security’s current problems. But this isn’t the first time the fund has been in trouble.
When the program first began phasing in, for example, workers were contributing but no one was retiring yet, so the fund grew a nice little surplus. Congress, seeing those nice big numbers, were generous with increasing benefits every time they had the chance.
When the 1970s rolled around, however, and those workers reached retirement age, that upward momentum came to a screeching halt. On top of that, a flaw in the program’s COLA formula that caused benefits to double-index, or increase at twice the rate of inflation rather than matching it.
It became such a hot mess that task forces were created, the error got its own name “The Notch Issue,” and instead of making changes to Social Security during even years, because increases and expansions were good for election campaigns, Congress made changes on odd-numbered years.
Social Security Amendments of 1983
Amendments in 1983 addressed the financing problems to the Social Security system. These changes were the last major ones to the program and were based on recommendations from a commission chaired by Alan Greenspan.
The Greenspan Commission adjusted benefits and taxes. The resulting reforms have generated surpluses and the buildup of a trust fund. However, many experts project that the retirement of the baby boomers, along with other demographic factors, will exhaust the trust.
What Can I Do About Social Security?
Perhaps the two most important tools in the journey toward retirement are education and planning—knowing where you are, where you want to be, and what you need to get there. SoFi’s article on retirement formula is one way to help get the process started.
In addition, understanding the ins and outs of the ideal retirement age, whether that’s through Social Security or private retirement accounts, and how to avoid penalties for jumping in too early—or waiting too long—can help form a solid plan.
Aside from government benefits, one of the easiest and likely most important step for traditionally employed workers is to take full advantage of their employer’s 401(k) matching plans.
It’s a way to not only save for retirement without having to put too much effort into it, but to save even more than might be possible without the match. For employees who have not contributed to their 401(k) in the past, a good matching program can help them play catch-up.
Without fixes, the cash reserves of the SSA will become depleted and workers who reach full retirement age after 2034 will not receive their full benefits.
It can be a scary proposition for some, but knowing that the deadline is approaching is a huge advantage in that members of the workforce who have time to take measures to counter the expected shortfall.
Self-employed workers also have investment options, including the IRA, Solo 401(k) and other plans. The advent of investment platforms, like SoFi Invest®, have also allowed everyone to invest in the market.
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