By Charlotte Cowles
Oct. 17, 2022
To most young people, few topics are as dull as Social Security. Or, as one 36-year-old friend put it to me recently, “I assume it won’t be around by the time I’m retired. Why should I think about it?”
Anqi Chen, who works as a senior research economist at the Center for Retirement Research at Boston College, hears this often. “I get asked this a lot at dinner parties,” Chen, who is in her 30s, said. “Many people have this notion that Social Security isn’t going to be there in the future. And it is definitely a misconception. Yes, there are pain points in the retirement system, but it’s important for people to comprehend what those problems really are.”
The future of Social Security does seem especially uncertain now, as a swell of aging baby boomers are depleting its funds faster than workers can top it up. (The 8.7% cost-of-living adjustment, announced Thursday, doesn’t help matters, although it does aid retirees who are struggling with rising prices.)
But this imbalance didn’t come out of the blue. “Since the ’80s, Social Security has built up its trust fund for the retirement of baby boomers, because it is a big demographic group,” Chen said. Current projections show that by 2035 the trust fund will be too diminished to sustain the level of benefits that people receive now. “One reason is that birthrates have gone down,” Chen said. “Another is that we’re all living longer, so we’re spending more time in retirement.” In short, the American workforce is shrinking as a large segment of the population ages out of it.
The shortfall may sound alarming, but it could potentially be solved by raising certain payroll taxes, cutting some benefits or pursuing some combination of both, Chen said. Even if Congress doesn’t act on it, Social Security will not “go bankrupt,” she added. “If nothing is done, then future benefits will eventually be reduced to about 80% of what current benefits are. That’s not ideal, but it’s very different from saying that we’re not going to get Social Security at all.”
Social Security has faced tougher obstacles in the past. When Franklin D. Roosevelt signed the program into existence in 1935, it had no budget, no staff and no facilities. Its initial funds were supplied by the Federal Emergency Relief Administration, and its office was bare until Frances Perkins, Roosevelt’s secretary of labor, donated a red leather desk chair.
The objective of Social Security, Roosevelt said, was to provide “some safeguard” against “the hazards and vicissitudes of life.” It was never intended to replace pensions, retirement savings, disability or life insurance but rather to supplement those plans and hedge against poverty.
Today, about 182 million people pay Social Security taxes, and about 70 million people — 1 in 5 Americans — receive monthly Social Security benefits. Most beneficiaries are retirees, but 1 in 3 are not; Social Security also provides benefits to disabled workers and survivors of deceased workers, including their spouses and children who meet certain criteria. Its formula has evolved over the years, but it remains a vital source of income for some of the country’s most vulnerable populations.
So, what should younger Americans know about Social Security? For starters, that future legislation will shape its role in the longer term. “We need people to understand the program, so that they can vote on measures that will affect it,” said Martha Shedden, co-founder and president of the National Association of Registered Social Security Analysts, which trains financial professionals how to maximize Social Security benefits for their clients. “Legislators could make small tweaks that would enable the program to continue mostly just as it operates now.”
Americans should also understand Social Security for their own retirement purposes. “No matter what, it’s not going to fulfill all of your financial needs in retirement,” said Kathy Indiano, an accountant who specializes in Social Security. “But it should still factor into your plan.”
Who pays for Social Security?
If you have a job, then you do. On your paycheck, you’ll see a deduction marked “FICA.” That’s an acronym for the payroll tax known as the Federal Insurance Contributions Act. As you work and pay FICA taxes, that money goes into the trust fund that will someday pay for your Social Security benefits.
For most employees, the Social Security tax rate is 6.2% of their wages up to an annual maximum, in 2023, of $160,200 (raised from $147,000 in 2022). Their employer matches that contribution by paying another 6.2% on the worker’s behalf. In total, an amount equivalent to 12.4% of each employee’s paycheck is paid into their Social Security account. It’s a similar structure to an employer-matched 401(k), except it’s not optional.
“A lot of people don’t realize that the payroll tax is just a contribution to a retirement account, similar to an IRA,” Shedden said. “It’s not like other federal government taxes. It’s going directly towards your future retirement plan.”
To see how much you’ve accrued throughout your working years, you can log into your account on the Social Security Administration’s website (or create one, if you haven’t before) and see the numbers, along with your projected benefits.
Are freelancers or self-employed workers eligible for Social Security?
Yes, and they actually pay more for it out of their pockets. Freelancers and self-employed workers are responsible for the full 12.4% of their Social Security tax (plus a 2.9% tax for Medicare). However, they can claim a tax deduction for the half they pay as their own employer.
Where does the money go?
When you pay Social Security taxes, the money is deposited into two financial accounts — known as trust funds — in the U.S. Treasury. One is the Old-Age and Survivors Insurance Trust Fund, which pays benefits to retirees and survivors of deceased workers. The other is the Disability Insurance Trust Fund, which pays benefits to workers who have become disabled. These accounts can be used only to pay benefits and program administrative costs; the government can’t dip into them or borrow from them for any other purposes.
The money in both trust funds is invested in Treasury bonds, which are guaranteed by the government. (Unlike the stock market, Treasury bonds are considered low risk and stable investments, although they tend to grow less over time compared with average stock market returns.) The trust funds earn interest on the bonds they hold, and when those bonds reach maturity or are needed to pay benefits, the Treasury Department redeems them.
How much money will I receive from Social Security when I retire?
Your monthly benefit depends on a couple of factors. The biggest one is how much you earn when you’re working (and, by extension, how much you pay into your Social Security account over time). The government averages your top 35 years of earnings, adjusts them for inflation and plugs them into a formula that determines your monthly payment. The formula is designed so that lower earners receive a higher percentage of their averaged monthly earnings, and higher earners receive progressively lower percentages. (The presumption is that higher earners have had more opportunities to save for retirement beyond Social Security.)
Congress periodically tweaks the formula based on life expectancies, income levels and cost of living. “There are many calculations that can be modified to extend the program and help it evolve as the economy shifts,” Shedden said.
Another element that helps determine your monthly benefit is the age at which you decide to start collecting it. Americans currently have the option to start receiving retirement benefits from Social Security as early as 62, albeit at a reduced amount. Your benefit will be higher if you hold off on taking it until you reach “full retirement age,” which is generally in your late 60s, though it depends on when you were born.
Are people who do not work, take time out of the workforce or receive their salaries under the table eligible for Social Security?
Sometimes. If you are single, you must have worked and paid Social Security taxes for at least 10 years to be eligible for benefits. (And, no, labor that’s compensated under the table doesn’t receive credit for Social Security.) But if you are married to someone who paid payroll taxes (for example, if you were a stay-at-home parent while your spouse worked), you are eligible for benefits that are based on your spouse’s. The same goes for former spouses who meet certain criteria. For instance, even if you divorced relatively young, you can claim Social Security based on your former spouse’s record later in life, as long as you were married for at least 10 years and have not since remarried. Survivors of deceased spouses can also be eligible for their Social Security benefits.
How might Social Security look in 30 or 40 years, when today’s youngest workers start to receive retirement benefits?
It’s tough to say exactly, but the program will certainly be around in some form. “Most millennials think that Social Security is not going to be there for them, and that’s scary,” Indiano said. “I don’t think that’s accurate or useful for planning, either. Is it going to be there in the same capacity that we have it today? Probably not. Are they going to have to contribute more to it during their career than, say, our parents did, for some of the same benefits? Most likely.”
The takeaway is that Social Security was always meant to be just one piece of the retirement savings pie, she added. For younger Americans, it might become a slightly smaller slice, and other forms of savings — like individual retirement accounts and 401(k)s — will probably need to fill the gaps.
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