Every year, the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds (OASDI) issues its annual report on the Social Security system. The report details the current financial status of both Social Security and Medicare as well future projections. The 2018 report has one key takeaway—both programs are facing long-term financial pressures and potential shortfalls.
How Social Security and Medicare are Funded
To better understand the report’s conclusion, you need to understand how the programs are currently funded. Both self-employment income and wages are subject to Social Security and Medicare taxes, known together as FICA (Federal Insurance Contributions Act) taxes.
Employees pay a Social Security tax of 6.2 percent and the employer also pays the same 6.2 percent again for a total 12.4 percent of every employee’s wages (under the wage cap of $128,400 for 2018) funding the system. Self-employed persons pay both halves themselves (although the “employer” side is tax deductible against total self-employment income).
Unlike Social Security, all wages are subject to Medicare taxes at a rate of 1.45 percent, paid by both the employee and employer for a total of 2.9 percent contributed to the system. Again, the self-employed pay both sides of the Medicare tax, just like the Social Security tax. In addition, anyone who earns more than $200,000 ($250,000 if married filing jointly) pays a Medicare surtax of 0.9 percent on all wages above those amounts.
Earning Your Benefits
Taxpayers need to earn a certain amount of credits in order to be eligible for Social Security benefits, with the amount depending on when they are born. Everyone born on or after 1929 must accrue 40 credits—which equals roughly 10 years of full-time work—to be eligible to collect retirement benefits.
How much you receive in benefits depends on how much you earned during your career. As of the April 2018 tables, individual retirees currently receive an average of $1,411 per month, or just under $17,000 per year.
Taxing Your Taxes
Taxes on Social Security benefits themselves also help fund the system. Depending on your filing status, age, how much you earn, etc., you might have to pay income tax on your Social Security benefits. These taxes are added back to fund the system for other taxpayers.
The Social Security and Medicare systems are more than 83 years old. During this time, the programs have taken in approximately $20.9 trillion in revenue and paid out about $18 trillion; leaving $2.9 trillion in trust fund reserves at the close of 2017.
Source of the Problem
Here’s the issue: the initial recipients didn’t pay into the system themselves—their benefits were funded by those currently working. The problem is that those entering retirement today represent a large segment of the population, while the working population is increasingly smaller due to declining birth rates. Together, this means the system is paying out more than it’s taking in.
For the first time since 1982, Social Security’s total costs will exceed its total income, according to the trustees’ report. As of now, the trustees expect to continue funding Social Security and Medicare using non-interest income (aka taxes), interest income on reserves and trust fund asset reserves. This leaves the system solvent through 2034, when the trust fund reserves will run out.
How Bad Is It?
Without structural changes or increased taxes, Social Security will be able to pay only about 75 percent of scheduled benefits after 2034 through 2092. Medicare is facing a similar, if not worse scenario.
The trustees suggest addressing the shortfalls as soon as possible. This is easier said than done, as any solution is going to be untenable to some group of constituents.
Potential solutions include reducing benefits now, raising the retirement age or increasing the wage cap for Social Security taxes. Even more draconian measures being considered include means testing to receive benefits or an outright increase in FICA tax rates.
The trustees’ report places a great emphasis on taking action now rather than later. The longer Congress waits, the worse the problem will become. But since all solutions are politically unpopular, legislators are unlikely to take any immediate action.