Proposals to address a looming Social Security budget shortfall tend to take two forms: reduce benefits to save money, or increase revenue to help fill in the funding gap. In either case, Social Security recipients are still likely to see lower benefits beginning next decade — and the cut could be as much as 20% compared with current payments.
As previously reported by GOBankingRates, the vast majority of current Social Security benefits — 75% to 80% — are funded through payroll taxes contributed by employees and employers. The rest comes from the Old-Age and Survivors Insurance (OASI) Trust Fund, which could be tapped out as early as 2032, according to a recent estimate from the Congressional Budget Office.
When the OASI fund is depleted, payroll taxes will have to cover all Social Security benefits. This means Social Security recipients face a roughly 20% reduction in benefits, according to the CBO. Addressing the funding gap means making some hard decisions about how to proceed.
“Something has to be done,” Alicia Munnell, director of the Center for Retirement Research at Boston College, told USA Today. “You either have to bring in more revenues or cut payments going out.”
One idea is to raise the full retirement age for claiming benefits — currently 66 or 67 years old, depending on your birth year. The FRA is the age at which you can get your full benefits. Claiming early means you will have lower monthly payments, while waiting as late as age 70 means you get the maximum benefit.
A plan released last summer by the Republican Study Committee would increase the FRA to age 70. The theory is that by pushing the age back a few years, more seniors would delay claiming benefits, which would help the Social Security Administration save money over the short term.
As USA Today reported, others who have floated the idea of raising the FRA for younger Americans include former South Carolina Gov. and 2024 GOP presidential candidate Nikki Haley, U.S. Sen. John Kennedy (R-La.) and U.S. Rep. Nancy Mace (R-S.C.).
But while raising the retirement age might put the SSA on sturdier financial ground, it “significantly cuts benefits for anyone retiring before their new full retirement age,” according to the National Committee to Preserve Social Security and Medicare (NCPSSM), a nonprofit advocacy group.
The NCPSSM noted that when the full retirement age was 65, workers retiring at age 62 received an initial benefit that was 20% less than their full benefit amount. When the FRA rises to 67, workers retiring at age 62 will receive a 30% cut in benefits. If the age were increased to 70, a worker claiming retirement benefits at age 62 would have their benefits reduced by nearly half, according to the NCPSSM.
The alternative to cutting Social Security benefits or raising the retirement age is to generate more money through higher payroll taxes. This could take a couple of forms. One would involve hiking the current tax rate of 6.2% for both employees and employers, or 12.4% for the self-employed. Another would involve raising the income threshold on wages subject to Social Security tax. Currently, any wages above $160,200 are not subject to the tax.
U.S. Sens. Elizabeth Warren (D-Mass.) and Bernie Sanders (I-Vt.) last month introduced legislation that would make the payroll tax apply to wages above $250,000. But those proposals are likely to run into resistance from anti-tax groups, and there is no guarantee that they will reduce the budget shortfall enough to prevent reduced Social Security payments.
Meanwhile, a bipartisan proposal to establish a sovereign-wealth fund to help finance Social Security might already be dead in the water due to the current banking crisis. Under the proposal, the fund would be built with $1.5 trillion or more in borrowed money. If the fund fails to generate an 8% annual return, Social Security’s maximum taxable income and payroll tax rate would be increased to ensure the program stays on track to be solvent for another 75 years.
However, the collapses of Silicon Valley Bank and Signature Bank and ensuing financial crisis have already threatened sovereign wealth funds used by other countries to finance public pension programs. It now seems unlikely that Congress would support a similar program to finance Social Security.
What this means for younger U.S. workers is that they need to prepare for the prospect of lower Social Security benefits in retirement, according to Craig Copeland, director of wealth benefits research at the Employee Benefit Research Institute. This means you’ll need to build up more retirement savings and/or work longer than initially planned.
“I don’t think anyone should be thinking that there won’t be any Social Security,” Copeland told USA Today. “There’s going to be some funding for benefits. It just won’t be what’s currently scheduled in law.”
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