Helping Nervous Clients Understand The (True) State Of The Social Security System And What It Means For Their Retirement

While the importance of Social Security varies depending on the wealth and other income sources of a given individual, its benefits play a role in nearly every client's retirement income plan. At the same time, frequent news headlines discussing the (un)sustainability of the Social Security system cause many working-age clients to harbor doubts that they will end up receiving the estimated benefits on their annual Social Security statement (and many current Social Security recipients might be concerned that they will not continue to receive their full benefits throughout the remainder of their lives).

In this environment, financial advisors have the opportunity to add value for their clients not only by giving a clear explanation about the current status of Social Security and the potential legislative changes that could improve its solvency, but also by using financial planning software to model the actual potential contingencies (from reduced benefits to higher taxes) and how they might affect clients' financial plans if a variety of scenarios were to come to fruition.

Social Security Is On An Unsustainable Path… But Will Still Be Able to Pay Most Benefits For Decades To Come

Each year, the Board of Trustees of the Federal Old-Age and Survivors Insurance (OASI) (which supports Social Security retirement benefits) and Federal Disability Insurance (DI) Trust Funds releases a report providing an update on the current and projected future health of the Social Security system.

According to the latest edition of the trustees' annual report for 2024, OASI Trust Fund reserves are now estimated to be depleted in 2033, while the reserves of a (hypothetically) combined OASI and DI Trust Fund, referred to as the Old-Age, Survivors, and Disability Insurance (OASDI) program, would be depleted in 2035 (the DI Trust Fund by itself is expected to remain solvent for the next 75 years). Nonetheless, this does not mean that Social Security retirement benefits would suddenly disappear if no legislative action is taken to remedy the situation before then.

Payroll Taxes Pay For The Vast Majority Of Social Security Benefits Received

While the state of Social Security's trust fund reserves often receives significant media attention, in reality, the bulk of funding for paying out Social Security benefits comes from Federal Insurance Contributions Act (FICA) taxes, more commonly known as payroll taxes (with workers and their employers each paying 6.2% on up to $168,600 of income [in 2024] for the Social Security portion of FICA).

While payroll tax revenues exceeded benefits paid between 1984 and 2009 (leading to a surplus that built up the trust fund reserves), Social Security's expenditures have exceeded tax receipts since 2010 (amidst an aging population leading to an imbalance between benefits paid and revenues received), resulting in ongoing withdrawals from the trust fund (through the sale of nonmarketable, special-issue U.S. Treasury securities purchased during the surplus years and reinvested over time) to cover the difference. Notably, these securities are backed by the full faith and credit of the U.S. government and are guaranteed with respect to both principal and interest as would any other U.S.-government-issued bond.

According to the actuarial status of the trust funds as of May 2024, the Social Security system received a whopping $1.23 trillion from payroll tax contributions and paid out $1.385 trillion in benefits (including both retirement and disability insurance payments), with the $155 billion difference covered by income taxes paid on Social Security benefits, interest earned on reserves, and actual withdrawals from the Social Security trust funds (at the beginning of 2024, OASDI reserves totaled $2.79 trillion).

Which means that even if the OASDI Trust Fund were to become depleted, the system would continue to pay the majority of benefits that are simply covered by the ongoing receipt of significant payroll tax revenue. In fact, according to the Social Security trustees, the combined OASDI Trust Fund would still be able to pay 83% of scheduled benefits in 2035, when it is expected to be depleted, though this figure would decline to 73% of scheduled benefits by 2098 (recognizing that forecasting economic and demographic conditions that far out into the future is inherently imperfect). Taken separately, OASI would be able to pay out 79% of scheduled benefits when the trust fund is expected to become depleted in 2033.

Which means, simply put, even if nothing is done to address the situation, the 'worst case' scenario (under intermediate economic assumptions affecting the system's future health) is that almost 4/5 of Social Security benefits would still be paid for the rest of the century!

Factors Determining The Future Health Of The Social Security System

In addition to taking stock of the current health of the Social Security system, the Board of Trustees annual report also examines the factors contributing to (or detracting from) the short- and long-term health of Social Security.

At a broad level, the primary factor driving the long-term challenges facing Social Security is the country's aging population (e.g., while there were 3.3 covered workers per OASDI beneficiary in 1985, there were only 2.7 workers per beneficiary in 2023) and the inability of taxable payrolls to keep up with the benefits being paid. For example, while Social Security costs represented 14.5% of payroll in 2023, revenues were only 13.4% of payroll (leading to the deficit requiring Social Security to tap into its reserves). This year's report estimates that costs will represent 18.1% of payroll by 2098, with revenue only increasing to 13.5%.

Nonetheless, this year's report showed mild improvement in Social Security's health, thanks primarily to updated economic data and near-term assumptions leading to improvement in the system's long-range actuarial balance. These included greater-than-expected economic growth in 2023 (leading to stronger assumptions for labor productivity), higher educational attainment (which tends to lead to individuals working – and paying into the system – for more years), more workers participating in the system than previously estimated, and a downward trend in disability applications and incidence.

However, lower estimates for the total fertility rate from 2.0 children per woman to 1.9 (reducing the number of individuals paying into the system in the future) dampened the overall level of improvement in the system's health (the total number of covered workers is also affected by net immigration; while the number of immigrants declined during 2020 and 2021 due to the pandemic, these numbers appear to be recovering, according to the trustees report).

Altogether, while this year's trustees report shows mild improvements in the near- and long-term health of Social Security, these are not nearly enough to counteract the cash deficit (and dwindling reserves bridging the roughly $150 billion annual gap between payroll taxes and benefits paid) the program faces and the potential for Social Security recipients to receive reduced benefits within the next decade or so. Which has led the trustees to recommend that policymakers address the projected shortfalls in a timely manner to gradually phase in changes (which could include changes to taxation and/or benefits) and to give workers and beneficiaries time to adjust.

Potential Policy Options To Promote Social Security's (Incremental) Sustainability

Given the disruption that a reduction of benefits would cause to recipients of Social Security retirement benefits (particularly for those who rely on them for a significant percentage of their retirement income), policymakers have an incentive to enact measures that will allow the system to continue to pay out full benefits for decades to come. Such options include single-policy solutions that would wipe out the entire 75-year shortfall, or a combination of policies that would close the funding gap. Which, notably, might not be as severe as some taxpayers might assume, because the vast majority of benefits would remain funded under current rules. Though, given the sheer size of the Social Security program, the remaining $150 billion funding gap (as of 2024) is not a trivial dollar amount, either!

Single-Policy Solutions To Close Social Security's Funding Gap

The 2024 board of trustees report offers single-policy solutions that would allow the (hypothetical) Old-Age and Survivors and Disability Insurance (OASDI) Trust Fund to remain solvent through 2098 (per current economic and demographic estimates).

On the revenue side, one option is to enact an immediate and permanent increase to the payroll tax of 3.33 percentage points (bringing the Social Security portion of FICA tax to 15.73%), increasing the income the system brings in to meet the demands of increasing benefits paid out. In dollar terms, a household earning $75,000 would pay approximately $2,500 in additional payroll tax annually, while a worker earning the maximum wages subject to payroll tax (currently $168,600) would pay approximately $5,600 in additional tax. Notably, given that payroll tax is only assessed on wages, other income streams (e.g., portfolio income or withdrawals from retirement accounts) wouldn't be affected by a payroll tax increase, dampening its significance for some taxpayers.

Alternatively, on the benefits side, an immediate and permanent (through 2098) reduction of 20.8% of scheduled benefits for all current and future beneficiaries would allow the system to pay out benefits through 2098. This would mean a reduction in benefits of approximately $400/month for a retired worker receiving the current average monthly benefit of $1,919 and a reduction of approximately $1,000 per month for an individual retiring at age 70 in 2024 and receiving the maximum monthly benefit of $4,873.

A related benefits-side option to close the full gap would be to maintain benefit levels for current beneficiaries, but to impose a 24.8% reduction in benefits on future recipients for those who become initially eligible for benefits in 2024 or later. In this case, a 2024 retiree receiving the maximum benefit would experience an approximate $1,200 reduction in their monthly benefits. While such a change would shore up the system without tax increases or benefit reductions for current retirees (while still paying out the majority of benefits to current workers when they decide to claim), near-retirees – who would have less time to plan for the change – could be particularly burdened by this policy option.

Policy Combinations To Shore Up Social Security Between A Payroll Tax Rate Increase Of 3.33 Percentage Points And A Benefits Cut of 21%

While these single-policy solutions could be politically challenging for Congress to implement (particularly the across-the-board reduction in benefits on current and future retirees, given that many seniors rely on these benefits to cover a significant percentage of their expenses), the trustees note that a combination of policies could also put Social Security on a more sustainable footing.

On the revenue side, policymakers have a range of options to boost funding to the system in addition to a maximum 3.33 percentage point increase in the payroll tax rate. For instance, Congress could decide to subject all wages (rather than the current level of wages up to $168,600) to the payroll tax, which would have a larger effect on many higher-income clients than would an across-the-board payroll tax increase, as it could subject wages above the cap to the full 12.4% Social Security portion of the payroll tax.

According to a 2023 analysis from the Committee for a Responsible Federal Budget, this would close approximately 60% of Social Security's 75-year shortfall (assuming that additional benefits would also be paid based on those taxes, given that Social Security benefits are calculated as a percentage of the wage base on which taxes were paid in the first place). This action, combined with a 1.35% increase in the payroll tax rate, would fully close the 75-year shortfall.

On the benefits side, policymakers could enact changes in the way benefits are paid out to reduce the costs to the Social Security system. Potential policies include the following:

• Raising the Full Retirement Age (FRA) from 67 to 68 (which would close 13% of the 75-year shortfall);
• Raising the FRA to 69 and then indexing it for longevity (which would close 39% of the shortfall);
• Slowing benefit growth for the top 70% of earners by growing benefits based on wage growth (which tends to be greater than price growth) for the bottom 30% of earners;
• Base benefit growth on prices for the top 30% of earners;
• Take a hybrid approach for those in between (which would close 58% of the shortfall); or
• Index Cost Of Living Adjustments (COLAs) to the "Chained Consumer Price Index (CPI)" (an alternate measure of overall inflation that attempts to account for changes in consumer spending patterns as prices change) rather than CPI (which would close 19% of the shortfall).

Alternatively, there have been some calls to index COLAs to "CPI-E", which attempts to measure inflation faced specifically by seniors (doing so would add 13% to the 75-year shortfall, creating the need to take additional revenue or benefit measures to close the gap).

As an example of how such policies might play out, recently introduced legislation, the "Protecting and Preserving Social Security Act", would index COLAs to CPI-E, eliminate the OASDI taxable maximum (i.e., subjecting all annual wages above $168,600 to payroll tax, phased in over 7 years), and pay out benefits for these wages above the current cap (a 3% benefit for averaged indexed monthly earnings up to $9,770 above the current cap and a 0.25% benefit for wages above this amount). An analysis by the Social Security Office of the Chief Actuary found that this legislation would allow the system to pay full scheduled benefits through 2053 and 91% of benefits in 2054, decreasing to 85% by 2098. Similar legislation has not advanced through Congress in prior years, though it is unclear what kind of reception this latest effort will receive.

In sum, while there is no shortage of potential policy options to shore up the Social Security system (which might not be as severe as some taxpayers anticipate, given alarming headlines about Social Security's health), the question remains when (and whether) Congress will act. Which leaves financial planning clients (and their advisors) in limbo (perhaps until the trust fund's exhaustion date draws closer in the early 2030s) when it comes to knowing whether full benefits will continue to be paid after the expected trust fund depletion date as well as understanding the impact of potential legislative measures (e.g., tax increases for those still working) on their financial plans.

Advisor Strategies For Discussing (And Modeling) The Future Of Social Security With Clients

Given the combination of regular news headlines discussing the solvency of the Social Security system and the fact that nearly all financial advisory clients are likely to be eligible to receive Social Security benefits, it is likely that this topic will come up during client meetings in the coming years (whether initiated by clients themselves or by advisors to provide perspective on an issue that might have a not-insignificant effect on a client's retirement, depending on their financial circumstances). Which gives advisors the opportunity to add value for their clients by providing context regarding the state of Social Security (e.g., even if the trust funds are exhausted, the system will still be able to pay out the majority of scheduled benefits) and potential fixes (which, depending on the legislation passed, might not be as severe as some clients assume), as well as to leverage financial planning tools to show the impact of possible policy actions on each client's financial plan.

Discussing Social Security Sustainability With Current Beneficiaries

The group most concerned about the possibility of receiving reduced Social Security benefits might be those who are currently receiving benefits and have possibly planned their spending based on the assumption that they will continue throughout their retirement (though according to a 2023 Gallup poll, 43% of current retirees expect to eventually experience a cut in Social Security benefits).

A first step for an advisor working with clients in this group might be to note that Social Security expects to be able to pay full retirement benefits for approximately the next 10 years and, absent any legislative intervention, would still be expected to be able to pay out approximately 83% of scheduled benefits starting in 2035 (because the vast majority of Social Security revenues come from payroll taxes paid by current workers). Which might surprise many clients who assumed that the insolvency date was sooner and that no benefits would have been paid thereafter.

In addition, advisors could highlight that many of the 'fixes' for Social Security involve revenue generation from still-working individuals (while also noting that a payroll tax increase wouldn't apply to the portfolio income or IRA withdrawals that help fund retired clients' spending) rather than from benefit cuts for current beneficiaries (and that retirees could actually receive greater benefits if Congress decides to tie COLAs to CPI-E).

Further, advisors can help clients see the actual impact of a potential cut in benefits on their financial plan by running alternative scenarios through their financial planning software, aided by the estimated required reductions found in the Social Security trustees report (e.g., a 20.8% reduction in benefits). Depending on the client's circumstances, they might find that even if Social Security begins to pay reduced benefits, their plan would remain in good shape (though they very likely will be frustrated if their benefits are reduced, even if they're still able to meet their retirement income needs!).

Social Security Solvency And Working-Age Clients

While the time frame to receive Social Security benefits may be further out for clients who are still working (particularly those who might have decades until they claim benefits), both the prospect of lower-than-expected benefits down the line when they do claim and the potential for legislative changes to affect their finances during their remaining working years make this a potentially relevant conversation.

Notably, many working-age clients might already be mentally prepared for potential downward adjustments to their expected Social Security benefits. For instance, a 2023 Gallup poll found that only 50% of non-retired adults expect to receive any benefits at all when they retire! Which suggests that this group might be relieved (and shocked?) to learn that they would be expected to receive more than 70% of their estimated benefits throughout their retirement, even in the absence of legislative action.

Such a scenario could be useful for an advisor to model with planning software to show what such a reduction would mean for the client's financial plan. And if the client was particularly pessimistic about Social Security's sustainability estimates (perhaps disagreeing with the trustees' estimates for future economic and wage growth), an advisor could model an earlier date for reduced benefits (e.g., before 2035) and/or a deeper cut to their expected benefits (e.g., a 35% cut that would reflect more pessimistic assumptions while still recognizing that payroll taxes are expected to continue to fund the majority of benefits).

Advisors could also add value for working-age clients by modeling how various policy proposals that reflect the actual magnitude of changes to shore up Social Security would alter these clients' after-tax income while working (e.g., raising the payroll tax rate by 3.33 percentage points) as well as when they would be able to claim benefits (e.g., raising the Full Retirement Age is raised by 1 or 2 years), and showing clients how these potential changes would affect their financial plans.

For higher-income clients, perhaps the most significant policy to model would be a potential lifting of the wage cap (above the current $168,600), which could expose their income above this level to the 12.4% Social Security payroll tax. Depending on their individual situation (and the policies modeled), many clients might find that the probability of success for their financial plan doesn't shift as dramatically as they expected under many scenarios (particularly if they previously assumed that their Social Security benefits would go to $0 starting in 2035!).

---

Ultimately, the key point is that while the Social Security system is currently on an unsustainable path, changes to benefits are not likely to occur for another decade, and even then (in the absence of legislative action), the program is expected to still be able to pay out between 73% and 83% of scheduled benefits for decades to come.

Nevertheless, given how a reduction of benefits would affect current and future retirees (particularly for those who rely on these benefits as a significant portion of their retirement income) and how Congress has historically taken action to shore up the system (albeit at the last minute), legislators might choose from one or more of a suite of options (e.g., a 3.33 percentage point increase in the payroll tax) to ensure Social Security is able to pay expected benefits well into the future.

Which means that advisors can ease clients' concerns about Social Security's future by providing context on the system's current health and explaining how potential changes to benefits (or taxes) could affect their own financial plans!