Second Thoughts About the ‘Third Rail?’

In recent days—notably at the State of the Union address—Social Security is back in the headlines.

Granted, its invocation seems largely intended as a political dividing rod, but it seems today that the vast majority (and despite the veiled insinuations, perhaps the entirety) of Congress and the President are committed to that system’s preservation, or at least rebutting its diminution. It appears that touching Social Security remains the “third rail” of American politics. That said, it’s going to take more than bold podium pontifications to fulfill that commitment.

It’s been called a Ponzi scheme by its critics—and, while not technically correct, there is a familiar element at work—the notion that money being deposited to the system now is basically going to be paid out to other beneficiaries. Indeed, in most Ponzi structures the scheme “runner” generally pays off longer-term participants with money invested by newer investors. Sooner or later, there are not enough new investors to fulfill those expectations and the whole thing blows up—though, depending on the sales skills of the Ponzi purveyor (and the expectations of the investors), it can run for years. Certainly one of the funding issues with Social Security is a result of having fewer new contributors relative to the payout to older participants,[i] if not by number, then by contribution amount(s).    

However, technically speaking, Social Security is not an investment program. Despite those individual withholding statements provided occasionally by the Social Security Administration, nobody has a Social Security “account” into which all those years of FICA withholdings (not to mention the employer contributions) are deposited. People who see those Social Security checks in retirement as a return of the money they put in (with interest) are misguided (at best), though politicians have long found it in their interest for workers to see a link between the two.

Whatever that system’s historic success, and the dependence of the nation’s retirees on its benefits, most surveys find a deep skepticism among the populace as to its long-term financial viability. However, that’s not a new sentiment. Along the way adjustments have been made over time to address those potential shortfalls—the retirement age has been lifted, the taxes withheld from current pay to fund that system have been increased, the benefits eventually paid from that system have been subjected to taxation (effectively reducing benefits)—and these days, most honest politicians will admit that those same kinds of changes will be required again to avert a future crisis.

Whatever you want to call it, to my eyes, Social Security is basically a societal retirement income insurance policy. Those FICA withholdings are premiums and, depending on our life circumstances, we may or may not collect on it. One thing is for sure, however: Whether it’s for life insurance, car insurance, or Social Security, when we make those payments, we expect that we will receive the benefit(s) for which we contracted. Older workers are, naturally, counting on receiving those benefits—because they have been told they can expect them by a reliable source, because they have spent a lifetime dutifully making those payments, and because they have seen their elders do the same.

Not only that, just try finding a retirement income needs projection that doesn’t have as a foundational baseline Social Security benefits. Or consider that an emerging strategy to compensate for retirement savings shortfalls is to use those savings to postpone Social Security claiming in order to maximize those benefits.[ii] Indeed, considering how many Americans rely on Social Security as their sole—or at least a primary—source of retirement income, you’d think addressing the looming shortfall would be a matter of high priority for policy makers. But for the most part—and the current enflamed rhetoric notwithstanding—it unfortunately still seems to be a problem that everyone agrees—someone else needs to fix.

- Nevin E. Adams, JD 

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[i] In 2022, there were an estimated 2.8 covered workers per each Social Security beneficiary. By 2035, the Trustees estimate there will be 2.3 covered workers for each beneficiary.

[ii] Some of the pushback on that argument is a concern that those future benefits will be trimmed—directly or through expanded “means” testing.

Social Insecurities

Last week the Treasury Department’s Social Security Board of Trustees released its annual report in a classic case of good news, bad news.

The good news, of a sort, was that the date through which Social Security will be able to pay scheduled benefits was projected to be 2034—and while that’s not very far away, it was a year later than the prior year’s report had indicated. The bad news, of course, is that without some kind of adjustment the program won’t be able to pay those scheduled benefits beyond 2034.[i]

Now, that’s not the same as “going broke” or running out of money—but, as things stand now—assuming no adjustment is made—a possible outcome would be that the scheduled benefits paid would only be about three-fourths of “scheduled.”[ii]

What’s weird is that it’s hard to find anybody who seems to think the problem won’t get fixed at some point—though the definitions of “fixed” vary—and nobody is willing to hazard a guess on who’s going to step up, much less when or how. 

The ‘How’

Of course, the how is relatively straightforward. Years back, when the future crisis was no less real, but somewhat less large, I had the opportunity to hear former Federal Reserve Chairman Alan Greenspan speak on the subject of “fixing” Social Security. Greenspan, who had led a commission in the early 1980s charged with solving what was then a much more immediate crisis of the program (believe it or not), outlined the two core elements of any serious attempt to resolve the funding shortfall:

1. increasing funding (generally either by raising the withholding rates or the compensation level to which they are applied, or both); and
2. reducing benefits, either by raising the claiming age —or what’s euphemistically referred to as “means testing,” which effectively reduces the benefits to higher income recipients. 

So, the answer to the problem is, as the actuaries remind us, “just math,” and we needn’t choose one solution or the other; rather, some combination—as it was in 1983—is the approach that seems the most likely outcome. That said, if there’s any aspect of this that is as widely known as the fact that there is a looming financial shortfall, it’s that the longer we put off taking steps to do so, the more difficult—the more expensive—it will be.

Whatever that system’s historic successes, and the dependence of the nation’s retirees on its benefits, I think most in my generation—and certainly those in my children’s—have doubts as to its long-term financial sustainability. Adjustments have been made over time to address those potential shortfalls—the retirement age has been lifted, the taxes withheld from current pay to fund that system have been increased, the benefits paid from that system have been subjected to taxation (effectively reducing benefits, particularly since those limits weren’t adjusted for inflation)—and most honest folk (even politicians) will admit that those same kinds of changes will be required again to avert the future funding crisis.

To get a sense for just how endemic Social Security is to retirement planning, just try finding a retirement income needs projection that doesn’t have as a foundational baseline Social Security benefits. Or consider that an emerging strategy to compensate for retirement savings shortfalls is to use those savings to postpone Social Security claiming in order to maximize those benefits. Indeed, considering how many Americans rely on Social Security as their sole—or at least a primary—source of retirement income, you’d think addressing the looming shortfall would be a matter of high priority for policy makers. But for the most part it seems to be left to “someone else, some other time.” 

Without a doubt, Social Security is most certainly the biggest retirement assumption—by individuals, retirement planners and legislators alike. At a time when we’re working to broaden coverage, to expand the impact of automatic plan design features, and the reach of state-run IRA programs, we know that as valuable, even essential, as those steps might be in broadening and deepening the success of the private retirement system—they won’t be “enough” if we don’t shore up the baseline foundation upon which the nation’s retirement security is currently predicated.

The “math” in the trustees’ report suggests we just picked up an “extra” year to solve the problem. Let’s not waste it.

- Nevin E. Adams, JD

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[i] Lest we forget, the Medicare program is in (even) worse shape. But that’s a post for another day.

[ii] Not that the potential beneficiaries have a solid grasp on how the program works even under the best of circumstances—see Many Near-Retirees in the Dark About How Social Security Works.