This post is a follow-up to our post of December 6, 2020 in which we suggested that, when developing your current year spending budget, “you consider the possibility that future Social Security reform may decrease the future benefits you receive from the system and/or increase your future taxes in some manner.” In response to that post, we received several comments questioning the premise that Congress would even consider the possibility of reducing Social Security benefits for beneficiaries in pay status. We fully understand that most people would prefer that someone else be required to pay the higher taxes and/ or have their benefits reduced in order to bring the system back into financial balance. In general, however, unless your means are very modest or you are very old, we believe it is more prudent for you to plan on some level of future benefit reduction or increase in taxes instead of simply assuming that the entire burden of achieving Social Security’s future financial balance will be borne by someone else.
In this post, we are going to select a few facts from the 2021 OASDI Trustees Report and a related Actuarial Note that we found to be of particular interest and which you may (or may not) find helpful in your retirement planning. We will use these facts to speculate on:
- Whose benefits and/or taxes are likely to be changed to adequately fund Social Security benefits in the future
- When those changes might become effective, and
- How much change will be required if and when reform becomes effective
We conclude our analysis by noting that even if Congress acts quickly to bring the system into actuarial balance (which seems unlikely to us), a fairness argument can still be made that baby boomers should be part of the solution to some degree. In the more likely situation where Congress fails to act or waits until the last minute to act, it may not be possible to avoid reducing benefits for some or all baby boomers in pay status.
While this post is intended, like our other posts, to help you make better financial decisions in retirement, it is different in that we spend a fair amount of the post diving into Social Security financing details and relatively complicated information contained in the Annual Trustees’ report. If you are not interested in reading about actuarial balances and other Social Security financial calculation details, feel free to skip this post or simply head directly to the conclusion.
The first item we are going to look at is Actuarial Note 2021.8. This actuarial note provides a concise summary of the actuarial results for the System since the 1983 Amendments placed the system in actuarial balance.
Actuarial Note 2021.8—Changes in 75-Year Actuarial Balance Since 1983
The Office of the Actuary of the Social Security Administration updates this actuarial note every year as part of the annual actuarial valuation process. Here is a link to the 2021 version of the note and Table 1 from the note is shown below.
This Table tells us several important things about System financing since the 1983 Amendments:
- The 75-year actuarial balance between projected System income and outgo has decreased fairly consistently every year since 1983 when the System last achieved 75-year actuarial balance.
- The 2021 75-year actuarial balance is now -3.54% of taxable payroll, or almost twice the long-range deficit solved by the 1983 Amendments
- Most of the decrease in the 75-year Actuarial Balance since 1983 (62%) has been attributable to the annual change in the 75-year valuation period used in the calculations (which we call the “valuation date creep”)
- Absent legislative changes in the system, the current 75-year Actuarial Balance of -3.54% is expected, because of the valuation date creep, to decrease every year in the near future even if all actuarial assumptions about the future are realized. It is likely reach over 4% of taxable payroll in the next ten years (best guess by just extending the annual decreases shown in the Valuation Period column of Table 1). See Side Note #1 below
- For at least the past 30 years, the OASDI Trustees Reports have been sending this consistent message about system financing: The system is out of actuarial balance and either taxes should be increased, benefits should be reduced or some combination of these changes should be enacted to put it back into balance.
Despite the consistent message delivered in prior annual Trustees Reports, no action has been taken by Congress to place the program back into actuarial balance. Arguably, much of the reason for this inaction is because
- There were still assets remaining in the OASDI Trust Funds,
- For many years those assets were increasing,
- There was no imminent risk of not paying full benefits, and
- No one was particularly excited about having their benefits reduced or their taxes increased
But, based on the information in this chart, one could certainly make a reasonably good case that since baby boomers failed to pay sufficient taxes to support their full benefits over at least the past 30 years (as evidenced by the declining actuarial balance), perhaps their full benefits should now be reduced to some degree if and when the System is reformed. In fact, just this case was made recently by Andrew Biggs in his Forbes article, “Social Security Benefits Aren’t Earned if You Didn’t Pay for Them.”
Side Note #1—Why Doesn’t the Annual Trustees Report discuss the expected Valuation Creep and its Implications?
The Actuarial Note above clearly illustrates the valuation creep in the 75-year actuarial balance calculation. It is not terribly difficult to project future years’ actuarial balance calculations if all assumptions made by the Trustees are realized. So, why isn’t the valuation creep and its implications discussed in the annual Trustees’ report? End of Side Note #1.
In light of the fact that actions to place the system back in balance have not been taken while the system still has trust fund assets, one wonders how motivated Congress will be in the near future to make difficult system changes as long as trust fund assets remain sufficient to fund full benefits. In the next two sections, we will discuss
- The default option if Congress makes no changes and trust fund exhaustion (TFE) occurs and
- Possible changes if Congress waits until the last minute (or nearly so) before TFE to make changes effective.
Default Option on Trust Fund Exhaustion
In this section, we will look at what will happen to benefits in pay status if Congress takes no action prior to projected trust fund exhaustion (TFE) to change the system. We call this the “default option.” For the sake of simplicity, let’s assume that TFE occurs on the last day of December in 2034 and Congress has taken no action to amend the System to increase taxes or decrease benefits. What would happen?
The Trustees Report provides us with information to determine what would happen under the default option. The table below has been excerpted from Table IV of the 2021 Trustees Report. It shows expected system income rates and cost rates for various years in the future under the Intermediate Assumptions. If the annual income rate for a year exceeds the annual cost rate for that year, this means that system income for that year is expected to be insufficient to fund expected benefit payments for that year (and other costs).
As shown in the table below, the income rate for 2035 is expected to be 3.49% of taxable payroll short of being able to fund the expected cost rate for 2035. Thus, only about 79% of 2035 system benefits (13.24% / 16.74%) would be expected to be funded under current law provisions and therefore, benefits in pay status would have to be reduced by 21% for that year. The table also shows that the extent of underfunding would be expected to grow in years following 2035 absent any Congressional action.
Annual Income Rates, Cost Rates, and Balances (As a Percentage of Taxable Payroll) for Selected Years Under Intermediate Assumptions
Year | Income Rate | Cost Rate | Balance |
2035 | 13.24 | 16.74 | -3.49 |
2045 | 13.28 | 17.05 | -3.77 |
2055 | 13.31 | 17.29 | -3.99 |
2065 | 13.35 | 17.80 | -4.45 |
2075 | 13.39 | 18.32 | -4.93 |
2085 | 13.38 | 18.14 | -4.75 |
2095 | 13.36 | 17.70 | -4.34 |
Source: Table IV. B1 2021 OASDI Trustees Report
Actions Needed to Achieve 75-Year Actuarial Balance If Changes Are Effective in (or Close to) 2034
Ok, how about if Congress waits until the last minute prior to TFE to make the changes necessary or enacts changes earlier but makes them effective at the last minute or close to the last minute?
On page 5 of the 2021 OASDI Trustees Report, the Trustees say,
“maintaining 75-year solvency with changes that begin in 2034 would require: (1) an increase in revenue by an amount equivalent to a permanent 4.20 percentage point payroll tax rate increase to 16.60 percent starting in 2034, (2) a reduction in scheduled benefits by an amount equivalent to a permanent 26 percent reduction in all benefits starting in 2034, or (3) some combination of these approaches.”
Side Note #2--Rant about above Trustees’ Report terminology
While we find the above numbers to be reasonable estimates, we would choose different words than those used above by the Trustees to more accurately describe the effect of increasing the tax rate, for example, to 16.60 percent starting in 2034 (or reducing benefits). Instead of “maintaining 75-year solvency”, we would say, “achieving a 75-year actuarial balance in 2034 based on Intermediate Assumptions”. Because there are no automatic adjustment mechanisms in the current law, the period of solvency resulting from specific changes enacted in 2034 will be a function of how reasonable the Trustees assumptions predict actual experience for the next 75 years. As a practical matter, then, such changes can’t be relied upon to guarantee maintenance of System solvency for any period of time, let alone 75 years. End of Side Note #2.
So, Let’s take a closer look at the how possible changes to achieve 75-year actuarial balance in 2034 described above could affect the following categories of individuals in the U.S.
- Beneficiaries in pay status
- Those eligible to be in pay status but who have chosen to defer commencement of benefits
- Those projected to be eligible to be in pay status within the next 10 years, and
- Those projected to be eligible to be in pay status in more than 10 years
Since the purpose of this post is to encourage you to consider planning ahead for possible reductions in your Social Security benefits, we are most interested in those combinations of changes effective in 2034 that might or might not affect benefits of those in pay status at that time.
100% Tax Increases. If we assume that income from taxation of Social Security benefits is .84% of payroll in 2035 and therefore the total cost rate of 13.24% for 2035 shown in the chart above is the sum of the current OASDI tax rate of 12.4% of pay plus the assumed income from taxation rate of 0.84%, raising the tax rate from 12.4% of pay to 16.60% of pay would produce a total income rate for 2035 of about 17.44% (16.6% plus .84%). This income rate would exceed the projected cost rate for 2035 under the Intermediate Assumptions of 16.74%, and there would presumably be no need to reduce benefits for anyone in the four categories above. Taxes would, however, be increased by 34% for all workers.
Presumably the accumulated excesses of the 17.44% Income Rate (which would increase slightly from year to year with increased tax revenue) over the projected cost rates for the first half of the 75-year valuation period starting in 2035 would be sufficient to fund the expected deficits in the last half of the 75-year valuation period under this change.
Side Note #3—Comment on robustness of 75-year actuarial balance “solutions” effective close to 2034
Since relatively small amounts of Trust Fund assets would be accumulated under this 100% tax increase alternative (or other solutions adopted in 2034 achieving a 75-year actuarial balance), actual system solvency would be very dependent on the accuracy of assumptions used to calculate the 75-year actuarial balance, and if actual experience was not as favorable as assumed, these “solutions” might not last very long without adjustments. All the more reason, in our opinion, to consider adoption of automatic adjustment mechanisms to keep the system in actuarial balance as part of the next system reform package. End of Side Note #3.
Increase Payroll Tax by 2 percentage points to 14.4% and Reduce Benefits in Pay Status and Future Benefits
Let’s assume that Congress feels that a 4% increase in the tax rate is too much and poses an unfair burden on younger workers relative to older workers and retirees. Let’s also assume Congress decides that tax rate increases should at least be part of the proposed solution. Under this alternative hypothetical combination tax increase/benefit reduction change, individuals in categories 3 and 4 above would not only have to pay higher taxes (about 16% higher), but we estimate they would also have their future benefits reduced by at least 13%. In addition, because the total income rate for 2035 would only be 15.24% (12.4% + 2% +.84%), taxes would be insufficient to cover the 2035 benefit cash flow discussed in the default option section above, and benefits for those in pay status that year would still have to be reduced by about 9% (15.24/16.74). We have no idea how this alternative would affect the ultimate benefits of individuals who are eligible to receive benefits but who are deferring commencement in 2034, but we imagine it would be a complicated calculation if benefit reductions for those in pay status are made permanent.
Highly Paid Workers to the Rescue?
Many people we talk with are relying on individuals who make significantly more than the Taxable Wage Base to provide the additional revenue necessary to fund the System. And taxing the rich may certainly help achieve greater balance (for Social Security and other government programs). In light of enactment of recent tax cuts favoring the wealthy and the influence of the wealthy in developing governmental policy, however, this may not be as easy to accomplish as people may imagine.
Conclusion
We have selected several simple examples to illustrate some of the complexities involved in addressing Social Security’s upcoming financial problems. Even if Congress acts relatively quickly, it may be difficult to argue against benefit reductions for at least some baby boomers. If Congress fails to act or waits too long to implement changes, Congress may have little choice other than decreasing benefits for individuals in pay status.
If, as part of enacting changes to restore actuarial balance, Congress grandfathers benefits of certain individuals (such as individuals with lower income levels or wealth levels), Congress may have to reduce benefits (or increase taxes) even more for higher net worth or higher income individuals. In general, we believe that taxpayers of all ages are going to be looking for some reasonable amount of intergenerational fairness in any package of changes enacted. We understand that you may not like to think about having your future Social Security benefit reduced, but you do have time to plan for this eventuality, and we once again encourage you to at least consider this possibility in your planning.
