What Happens When Social Security Goes Bankrupt?

     Social Security is a program that's near and dear to our hearts. I think we all know there are some issues with the system. Maybe some of us figure we'll be long gone before Social Security runs into real trouble, so it doesn't really affect us. Others think everything is just okay the way it is, and their only concern is how to squeeze the most money they can out of the system. Still others are sure there's a government conspiracy, or a right-wing conspiracy, or a corporate conspiracy -- or some kind of conspiracy -- to deprive us working men and women of the benefits we've earned and deserve.

     I don't pretend that my own views can stand up as an authoritative voice on Social Security. So instead, I've gone to my financial consigliere, Jeremy Kisner of Surevest Wealth Management in Phoenix, AZ. He is a Certified Financial Planner and Chartered Retired Plans Specialist, with a degree in economics from UC Santa Barbara.

     I have no financial connection to Kisner (although I might be a little more flush if I did!) But last year he helped me out by penning a post for Sightings Over Sixty called Is Long-Term Care Insurance for You? Recently, I saw on his Weekly Insight a very clear, concise and straightforward analysis of how to "fix" Social Security. And so with his permission I have reproduced it here:

What Happens When Social Security Goes Bankrupt

Jeremy Kisner

     It’s a trick question. Social Security will not go bankrupt. However, if no changes are made to the current system, the “trust fund,” which was built up by collecting more payroll taxes than it paid out, will be depleted. Benefits would need to be reduced at that point to match the payroll taxes being collected. That would happen sometime between 2033 and 2037 if we do nothing. Once the trust fund is depleted, benefits would be cut to approximately 75% of their current level to keep the system solvent through 2087. The reality is this “do nothing” approach is unlikely as there is growing pressure to “fix” the system.

     So, let’s fix the system. The options are:

     1) Increase payroll taxes. This is the simplest and most effective. The current payroll tax collects 6.2% from employees (and another 6.2% from employers). This would need to be increased to 7.6% to keep Social Security benefits fully paid for another 75 years, according to a study by the National Academy of Social Insurance. It will take some cash out of workers’ pockets, which is never popular and will hurt economic growth. Imagine that…if we put more away for the future, we have less to spend today.

     2) Eliminate the cap on taxable earnings. The cap currently limits the 6.2% payroll tax to the first $118,500 of earnings. We could close approximately 70% of the Social Security funding gap if the cap were eliminated entirely. This would only affect about 5% of the workforce, who have wages above $118,500. These people may be a bit perturbed because they already have the worst return on their Social Security contributions.

     3) Raise the retirement age. This seems logical since people are living so much longer than they did in 1935 when Social Security began. Unfortunately, this solution is surprisingly ineffective. A three-year increase in the full retirement age from 67 to age 70 for people born after 1960 would only cut the funding gap by 25%.

     4) Means-testing for beneficiaries. This would mean that high income retirees would have their benefits reduced or eliminated since presumably they don’t need the benefit. Polls found this option to be highly unpopular with voters who thought it was unfair.

     The likely scenario is some combination of these options. While Congress is figuring out all of this, I encourage you to save as much as you can. After all, the maximum Social Security you can collect at full retirement age in 2015 is only $2,663 per month and I have a feeling most people reading this article will want to spend more than that.

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     I don't know what your preferences are, but as a person who works for himself, part time, and therefore pays the full amount of the Social Security tax himself -- which is basically 15% on top of everything else -- raising the tax would be pretty punishing, a real disincentive to work at all. (Plus, remember, even if you work for someone else, the "employer's" half of the payroll tax really comes out of your pocket, not their pocket.)

     Also, the payroll tax is a regressive tax. If you make minimum wage, it takes 15% from your paycheck. If you make $50,000 a year, it takes 15% from your paycheck. If you make $250,000 a year, it takes about 7% from your paycheck. If you make more than that, it takes even less.

     So to me, the obvious solution is #2 -- eliminate the cap on taxable earnings, so everyone pays at the same rate. But like I said, I'm no authority. Maybe you have some other ideas.