If you are 24 years old today and expect to begin receiving Social Security benefits at age 62, you may be in for a surprise. In 2043, benefits for retirees may be reduced by over 25% and continue to be cut back each year thereafter.
A System in Jeopardy
Why has the durability of the Social Security system come into question recently? According to the 2004 Social Security Trustees' Report, an additional $3.7 trillion will be needed to keep the system running through 2077. Coupled with a Congressional Budget Office report predicting Social Security and Medicare expenditures to increase around 75% by 2030, economists seem to have no certain answers now. (All financial projections are based on the intermediate estimates of the 2004 Social Security Trustees' Report.)
While today's retirees can probably count on receiving their Social Security benefits, future generations may not be so fortunate. This is largely due to increased longevity, rising costs of medical technology, and the impending retirement of the baby boomer generation (individuals born between 1946 and 1964).
When substantial numbers of the baby boomers begin to retire between 2010 and 2030, Social Security surpluses are expected to dwindle rapidly. By 2018, it is projected that its annual cost will outpace tax income and will be replaced by growing annual cash deficits. In turn, net Treasury payments to the Social Security system will greatly increase pressure on the federal budget.
Here's why:
When Social Security income exceeds its expenses, the surplus is retained by the Treasury and used to meet the government's non-Social Security expenses. For example, the recent surpluses in Social Security led to annual surpluses that went to finance B-2 bombers, farm subsidies, savings and loan bailouts and other general federal expenditures. In return for borrowing these funds, the Treasury issues special bonds to the Social Security trust fund. Through 2003, the Social Security trust fund held $1.5 trillion in bonds.
When Social Security's expenses exceed its income, theoretically these bonds can be redeemed to meet current obligations. Beginning in 2018, the Treasury will need to begin redeeming these bonds and the government will have to find the cash to repay the money it borrowed. Even if the bonds can be redeemed without any problems, Social Security will most likely have serious problems beginning in 2042 and will need to change.
Sell bonds to the public—Whether the public has sufficient appetite to buy additional bonds at an average rate of $500 billion per year, even in the inflated dollars of the 2020s, remains to be seen.
Raise taxes—Policymakers can raise taxes to provide the Treasury with the necessary money. More directly, they could raise Social Security taxes, reducing the need for bond redemptions.
Print money—This would increase the inflation rate. Because Social Security benefit increases are tied to changes in the Consumer Price Index, inflation would result in even higher benefit costs and the need to redeem bonds more rapidly, not to mention other deleterious economic effects.
What Policymakers might do rather than trying to redeem the trillions of dollars in bonds accumulated over several decades, policymakers would likely enact a package of revenue increases and benefit reductions that would bring Social Security's income and outgo into balance in 2018 or shortly after.
The following big ticket items are likely to be included in such a package:
Increased Social Security Taxes—Tax increases are easy to explain, and most workers pay the additional amounts through withholding from wages and salaries.
Reductions in COLAs—Social Security's cost-of-living adjustments (COLAs) were delayed six months by legislation in 1983. They could be delayed again, reduced or frozen temporarily. Many economists believe that the Consumer Price Index, which is the basis for Social Security's COLAs, overstates inflation in any case, although the government has taken steps to reduce this overstatement.
A Higher Normal Retirement Age (NRA)—Social Security reform legislation in 1983 raised the NRA gradually, from 65 for workers born before 1938, to 67 for those born after 1959. Congress has already demonstrated that it can raise the NRA, and there is no reason to believe that it will stop at age 67.
Other Revenue Options—Lastly, other alternatives under discussion include using general revenues to sustain the Social Security system, or prefunding future benefits with personal savings accounts or direct investments of the trust funds. (Social Security's Future—FAQs, www.ssa.gov/qa.htm.)
It certainly appears that the Social Security program will not be as generous for tomorrow's retirees as it is for today's. People who hoped to be enjoying their retirement after 2018 should probably start saving more now if they want to maintain a comfortable standard of living after retiring. Usually, the necessary amounts needed for retirement cannot be saved during the last few working years; it is recommended that they be accumulated over a much longer period of time.
Today's workers need to know that the future of Social Security is uncertain so they can design their retirement plans accordingly. Talk with your investment professional to learn how to prepare for your future.
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