Is Social Security Really Going Bankrupt?

bigfootFor most folks, the Social Security system and how it works is a mystery.  Many believe that there is an account somewhere with your name on it, and you’ll get to draw funds from that account when you retire.  Other folks will tell you that the system is bankrupt or nearly so.  Still others will swear that it’s a Ponzi scheme. These are mostly myths.  So what is the truth?

How The Social Security System Works

In a way, the Social Security system actually does resemble a Ponzi scheme, in that the early participants paid in very little and received an inordinately large benefit (by comparison to what they paid in) – while later participants will be paying in a far larger amount, likely more than they will ever get back out in benefits.  To be a true Ponzi scheme though, the later participants would be told that they can expect the same return on investment that the earlier folks received.  I think we’ve understood for quite some time that this isn’t an investment, but a tax – and that we may get very little out of the system compared to what we put in it. From the beginning, the Social Security system has overtly been a “pay as you go” system, meaning that current receipts from tax withholding are used to pay present-day recipients of benefits.  Most of the time during its 75-year existence, the system has been paying out less in benefits than it is taking in from withholding, and so the surplus has been placed in a “trust fund” to help pay for benefits in the future.  This trust fund amounts to roughly $2.5 trillion these days. This design was based upon the (incorrect) assumption that each succeeding generation would be larger than the previous generation, therefore the receipts would always be greater than the payouts.  That was before the Baby Boom. It has been projected that, beginning in 2017 (although I’ve seen it reprojected to 2016 lately) that the system will begin drawing from the trust fund regularly, although the interest alone on the trust fund’s account will be enough to cover the excess needs of the system through 2027.  At that point, it is projected that the principal in the trust fund will be accessed to pay benefits, and the trust fund principal is expected to be exhausted by 2041.

So – What’s Going to Happen?

I can’t tell the future, but I have a couple of guesses as to what may occur.  But first, I wanted to point out a couple of recent developments: 1) In 2010, due in part to the economic downturn, the Social Security system is expected to pay out more than it takes in.  This is not a catastrophe, and not expected to be a long-term trend, nor is it the first time this has happened.  It is, however, unexpected, and may have a big impact on the crossover point projected in 2017 2016.  This is primarily due to unemployment staying high (less money coming in due to smaller payrolls).  Stay tuned, but also see #2. 2) The long-term trend that will likely have the greatest impact on the health of the Social Security system is the delay of retirement among many Americans, specifically the troublesome Baby Boom generation.  According to some recent data from the Rand Corp., the percentage of folks between 65 and 75 that are still active in the workforce will be 25% in 2010, versus 17% in 1990.  That’s a significant fact, because those folks are continuing to pay into the system, and either delaying receipt of benefits or receiving a smaller benefit (at least until Full Retirement Age) than was projected. The combination of these two factors is likely to improve the outlook for the overall system, although we’ll have to wait for the witch doctors actuaries to sift through the numbers to know what the new projections will look like.

My Guesses

In the meantime, here’s my guess as to what will happen:  like anyone with a finite budget, when it comes time to begin paying out of principal, I expect for benefits to be reduced across the board – possibly by as much as 25%.  But before that happens, I expect that we’ll see increases to the ages for benefits, such as bumping up the early retirement age from 62 to 64, and the maximum benefit age from 70 to 72.  These increases would match the increase in the Full Retirement Age that has been in place for some time now.  And lastly, plan on the fact that pretty much any benefit you receive will be taxed to some degree.
Regardless, all this talk about going bankrupt is pretty much ill-founded.  Since the system has the ability to draw in tax rolls it cannot be bankrupted; benefits can reduce and ages for benefits can increase, but it can’t go completely broke.  It’s bad, but not catastrophic.  It’s sort of like if we were to discover that, after all of the sightings and legends over the years, it turns out that Bigfoot isn’t really an unknown species, but rather that it was just members of The Allman Brothers Band wandering about in the wilds.  Frightening, but not the end of the world.

So What Can You Do?

Write your congressmen & women.  Light a candle.  Wring your hands, and say “oh my”.  And then just get over it, realizing that Social Security should not be counted upon as a significant portion of your retirement income – especially if you were born after about 1955.  Concentrate on your savings, and then, if the Social Security fairy happens to leave something under your pillow when you are retired, consider it gravy.
Photo 1 courtesy Wikipedia
Photo 2 courtesy Georgia Informer
IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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