We talk (well, write) a lot around here about the importance of saving for retirement: For most, taking even a small chunk from your paycheck to beef up an IRA or other retirement account is a critical first step to ensuring comfort down the road for you and your loved ones. You aren’t the only one trimming that salary with an eye toward retirement, though—Uncle Sam does the same via the payroll tax, aiming to provide you with a modest stream of payments to supplement whatever other cash flow you have. But will it be there when you need it? Americans have long feared Social Security isn’t sustainable. Let’s take a look at the concerns and critically weigh them.
Fears of Social Security running out of money are widespread and long-running—from 1996 to 2006 to now. All these dour predictions have had a real effect: Nearly half of Americans say they don’t expect to receive any benefits from the program, and another third anticipate fewer benefits than are now promised. Most recently, a government report projected that by 2034, the system will no longer be able to compensate recipients at current levels—or as the usual headline describes it, “Social Security trust fund will be empty in less than 20 years.” This conjures up images of an empty bank account, betraying all those who paid into it. Was it robbed? Was the money ever there? What happened? In reality, this imagery is mistaken, and the claim overstated. To allay worries of its impending demise, let’s first clear up some misconceptions about how the system works.
Your payroll taxes may come from a paycheck with your name on it, but that doesn’t mean they go into a dedicated account, grow over time, and then return to you upon retirement. There isn’t even a collective lockbox. Social Security is pay-as-you-go: Today’s receipts from workers are today’s distributions for retirees. Just like any other form of government spending, money comes in and money goes out, more or less at the same time. This isn’t to say the two always equal each other, either for Social Security or elsewhere. After accumulating for decades, outlays exceeded the program’s non-interest income for the first time in 2010, as they have each year since. But that doesn’t mean the program is on the fast track to insolvency.
Remember, these fears have been around a long time, and Congress has acted to beef up Social Security before—not just once or twice, but seven times! Each action tweaked the system to extend its lifetime: In 1983, for example, Congress raised the retirement age and bumped up the tax rate. Similar adjustments today, even small ones, could make a big difference. One proposal—lifting the marginal tax rate by an unremarkable one percentage point—might patch the shortfall for an additional 75 years. Other potential revisions, like changing how cost-of-living increases are calculated, could also prolong the program’s viability. And politicians, for all their (many!) faults, have a big incentive to maintain the program: Voters support it by wide margins. This doesn’t mean reforms are coming soon, of course. Can-kicking is a favorite pastime in Washington, D.C., and last-minute fixes are common. In recent memory, Congressional wrangling over issues like the debt ceiling and fiscal cliff shows how bumpy a bill’s road to the president’s desk can be. But with such a huge constituency behind Social Security, reforms are highly likely to occur long before a crisis hits.
In any case, these possibilities are all very distant—even skeptics’ worst-case scenarios play out decades from now. So much could change! Consider that, today, more and more people choose to work longer, delaying their benefits. Some use this time to shore up savings. Others just enjoy staying connected to their peers. As Millennials—who outnumber their Baby Boomer parents by 15 million—enter their prime earning years, revenues supporting current retirees should grow. Any number of other economic changes could intervene, rendering today’s handwringing moot.
The Social Security Administration, like other government agencies, can’t account for these possibilities, because they use straight-line math to project current trends into the future. While these projections might help paint a picture of what could happen, they are vastly inadequate for predicting what is likely to happen. Few groundbreaking economic developments of the last few decades—the Internet, China’s rise, mobile technology—were widely forecasted, much less by government officials. Whatever today’s concerns, it is far too soon to analyze how tomorrow’s unknowns will affect Social Security.
For investors today, the takeaways are simple: First, while reforms are possible, if not probable, Social Security isn’t going to vanish any time soon. Whether you’re receiving benefits now or hope to in the future, and while the future is yet unwritten, know that this isn’t some untouchable third rail that will reject reform and ensure its own demise. Reforms, if needed, are likely to be mild, and there is plenty of time to phase them in. As far as your investments are concerned, markets don’t move on distant fears like these—they look most closely at the next 12-18 months, or 3 years, at the long end. Your retirement future—or present—is best served by sticking with your long-term investment plan, and tuning out over-hyped worries like this one.