Frequently in the comments section of retirement-oriented articles, a reader will post that he "doesn't expect to receive any income from Social Security when I retire" and is planning accordingly. Polls repeatedly find that roughly 50% of Americans who are not yet retired believe that Social Security will not be around and paying benefits when they retire. I can remember the first time I heard that sentiment expressed: it was in the 1960's and the person telling me that was my mom.
The belief that "there will be no social security when I retire" could pose a problem for folks who decide to embark on a high-risk investment strategy in order to have what they feel will be "adequate income" in retirement. As I noted in my earlier articles about high yield investing, there actually is no way to magically increase income so as to replace the tens of thousands of dollars of retirement income which Social Security will be providing those of us who have worked and paid into the system throughout our working lives. Chasing yield through high risk strategies and schemes is a dangerous game. My mom took that route. When she passed away a few years back, she was still receiving money from Social Security every month - long after all of her investments and business plans had gone belly up.
For those concerned about having adequate income in retirement, the best approach for most people is to take steps to prioritize and maximize your Social Security benefit - even at the expense of your investment portfolio - because it is the most reliable source of monthly income most people will ever have an opportunity to receive. Social Security is more likely to "be there" for you than any investment you can possibly make. In this article I laid out one approach for doing so.
Given the amount of misinformation which is prevalent regarding this basic element of retirement planning, I thought it would be worthwhile to describe what the Social Security system is, how it works, and why it will still be there, paying benefits, when each of us retires - and to debunk some of the myths which feed the belief that it won't. Those myths traditionally include the assertions that Social Security is "bankrupt," "a Ponzi scheme," and that "Congress spent the money in the Social Security trust fund." A more recent myth is the belief that illegal immigrants are entering the country and receiving social security benefits, endangering the financial stability of the fund.
None of those things are true. Each reflects a fundamental misunderstanding of what Social Security is and how the system operates.
The official name of Social Security is Old Age, Survivor and Disability Insurance - OASDI. The name is the first clue: it is insurance. It's not savings, not a pension, not an "entitlement" (if that word has any meaning anymore). Like all insurance, you pay your premiums on a periodic basis, and when and if a "covered event" happens after you have paid in for the time required to vest in the system, you get paid. The "covered events" are 1) getting old; 2) becoming disabled, and 3) being the dependent of someone who is old or disabled. If you don't pay in long enough to get vested (typically 10 years), you don't qualify for benefits. If you die before a "covered event" happens, you get no return on your premiums, any more than you would get one from your fire insurance policy if your house didn't burn down or from your auto insurance if you don't get in an accident. Understanding the basic nature of OASDI is key to understanding why so many people get it so wrong.
The way OASDI has worked from day 1 is on a "pay as you go" basis, like most insurance programs. The Social Security Administration (SSA) doesn't sock your contributions away in an account, waiting for you to retire so your money can be returned to you. The money paid in each year by workers (referred to as FICA taxes) is turned around and paid right back out to retirees. In a sense our parents paid in for our grandparents, we've paid in for our parents, and our children's generation will be funding the system when we are withdrawing our benefits. When the amount of taxes paid in exceeds the benefits being paid out, the system has a surplus. That surplus is invested in the safest and most stable investment on earth: US Treasury bonds and notes. As a result, there is a Social Security trust fund consisting of interest-bearing Treasury IOUs which holds the accumulated surpluses built up over the years.
There are separate trust funds for the old age and survivors part- OASI - and the disability insurance part - SSDI. I'll be talking about the OASI part, which is the part that funds retirement. The numbers for the SSDI part are much smaller and a little different but not enough to change the overall picture. Also, Supplemental Security Income - SSI - is frequently confused with SSDI. SSI is a welfare program which is not funded from social security taxes. It is administered by the SSA for a fee but its funding doesn't affect the OASDI funds.
In recent decades the OASI system has run substantial surpluses each year, causing the trust fund to grow over time. This wasn't always the case; in the past there have been a number of years when the SSA drew down the surplus to cover the benefits paid out, most recently in the 1980s.
Social Security isn't "going bankrupt."
So why are people saying "Social Security is going bankrupt?" After many years of running surpluses, the aging of the Baby Boomers is upsetting the actuarial balance of the system. With more and more boomers retiring each year (and many of us living longer) the relatively smaller Gen X working cohort and the young millennials aren't earning and paying into the system at the same rate the boomers did. As a result the annual surpluses added to the trust fund have been shrinking. At some point - fairly soon now - the payments going out will equal, then exceed, the FICA taxes being paid in.
But that won't mean that Social Security is "bankrupt." At that point the SSA will have to start cashing in the Treasury bonds in the trust fund to meet the benefits, just as it has done in the past. The OASI trust fund has almost $3T worth of Treasury bonds in it, so the shortfall between FICA taxes paid in and benefits paid out will be covered for quite a while yet from that source. Still, at some point, if no changes are made to the benefits or FICA rates the trust fund will probably run out. We can't know for certain when that will happen; it has been projected to be most likely to occur in the 2030s or 2040s, possibly as late as the 2080s. (Demographics aren't static - the Millennial generation is even bigger than the boomers, and when Gen X retires there's not so many of them. It's too far off to try to project how it will all balance out with a high degree of confidence.)
But even then the Social Security system won't be "bankrupt." It will still have FICA tax revenue coming it, available to be sent back out to pay benefits. Current estimates are that if nothing is done to respond to the developments the incoming FICA revenue will be sufficient to fund roughly 75% of the currently scheduled benefits.
That is the worst case scenario. Retirees would receive somewhere between 70% and 80% of what they would get under current benefit standards. But we would still get paid, every month.
It's also an unlikely scenario. Because there are lots of things that could be done to deal with the demographic developments. Most frequently mentioned are:
1. Raising the full retirement age or FRA, which is 66 for current retirees and is now scheduled to gradually rise to 67 for those born in 1960 or later. Raising the FRA is an indirect way of cutting benefits for future retirees, since most people start taking their benefits before reaching their FRA, and the further you are away from FRA when you start your benefits the less you get.
2. Increasing revenues by raising FICA tax rates and/or the upper limit on which earned income is taxed. This hits workers, particularly high earners.
There's also a third route, which has been used in the past: have the government pay money to the SSA from general revenues instead of relying exclusively on the FICA tax. This could be done by a straight grant of money (which has been done in the past for various reasons) which would shift some of the cost from taxing only earned income to taxing investment income as well. It could also take the form of having the SSA issue bonds which are purchased by the US Treasury, reversing the flow of funds between those two entities from the recent past. (This has also been done before.)
There is good reason to believe that one of those things will be done, and possibly a combination of them. But no matter what, there is a high probability that Social Security will be around and still paying benefits which are not much different from what retirees today are receiving whenever anyone who reads this retires.
Let's debunk some of the other myths.
1. "Congress took the money from the Social Security trust fund and spent it!" No one ever "stole" money from the trust fund. Congress never combined trust fund money with general tax funds and spent it. In fact, since day 1 the surplus has been handled in exactly the same way. But in the late 1960's there was a debate over how to record the funds held in the SS Trust fund for accounting purposes: as a separate entity or on the same spreadsheet with the other government programs. For about 20 years the funds were listed together, then in 1990 they were broken out separately again. But that was simply a matter of accounting - no actual change in how the funds were collected, invested, and paid out ever happened.
2. "Social Security is a Ponzi scheme." In a Ponzi scheme the promoter creates a story that he has discovered a secret way to make large profits, and convinces gullible investors to buy into the scheme by offering a return that can't be matched through legitimate investments. In fact, the promoter of the scheme is just using new investors' money to pay off any of the earlier investors who want to cash out. The promoter issues reassurances and statements showing accumulation of large profits as a means of convincing most of the marks to reinvest - frequently increasing the maturity date of the investments. Eventually the system breaks down because the "profits" are fake, and either the promoter absconds with the funds he has raised or there is a run on the fund by investors trying to cash out which causes it to collapse.
As you will note, Social Security doesn't have any of the characteristics of a Ponzi scheme other than the fact that early "investors" are paid from funds contributed by later "investors." But that is a characteristic of all forms of insurance; it doesn't make it a Ponzi scheme any more than every insurance company in the world is a Ponzi scheme. There are no promises of secret formula profits in Social Security; the entire system is entirely transparent.
Many people who call Social Security a "Ponzi scheme" confuse that term with "pyramid scheme" like the old chain letters which require a constant flow of new "investors" to pay off - ultimately collapsing because there is not an infinite number of people to be brought into the pyramid. Again, social security does not require an infinite number of participants; it has worked fine for decades because it is based on actuarial analysis of the American workforce.
3. "Illegal immigrants are draining the Social Security fund." There are only two types of people eligible to receive payments from social security: those who have paid into the SSA for over ten years (40 quarters) and the spouses and children of people who have paid into the system for over ten years. People who are in the country without the legal right to work here can't collect. The usual workaround for non-citizens who don't have a green card is to either work "under the table" or work (and pay in) under a fake social security number (SSN) But you can't collect under a fake SSN. And you can't collect if you've worked "under the table" because you won't have paid in for the required ten years. (Illegal workers working under false SSNs are actually a net benefit to the system, paying billions in FICA taxes each year that they can't collect against.)
Much of this myth comes from confusing SSI with SSDI. (There are prohibitions on illegal immigrants receiving SSI as well but that's beyond the scope of this article.) Even if an immigrant could receive SSI benefits the payments wouldn't come out of the OASDI fund.
Social Security will be here, paying benefits very much like the current benefit structure when we all retire. The "fixes" needed to extend the program beyond our lifetime are modest. The psychological "full faith and credit" of this great nation stands behind Social Security and the people of America are not about to let it fail. Banks fail. Insurance companies fail. Dividend champions suspend their dividends. Metals, oil and commodities rise and fall in value. BDCs, MLPs, REITs, and C-corps - including "blue chips" and "aristocrats" - all have failed. In any circumstances short of an all out zombie apocalypse, Social Security will not fail. (And if the streets are full of flesh-eating walking dead the status of your investment portfolio will not be your primary concern!)
Sensible financial planning for retirement should include the understanding that income from Social Security is a revenue stream that is more reliable than any investment you can make. Like my mom, you will see that deposit into your bank account every month until the day you die. Plan on it.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.