The most considerable boost in Social Security benefits since 1981 was great news for retirees. However, it also served as a clear reminder that the program is costly, with benefits cuts expected unless it’s retooled in the coming years.
With the announcement of the benefit boost, last week came the word of a tax increase for many Americans, with salaries subject to the Social Security payroll tax scheduled to jump about 9% next year.
Even before the announcement of the cost-of-living adjustment (COLA), the Social Security trust fund was projected to run out of reserves by 2035 if nothing was done. Historically, Social Security reforms haven’t been well received by the public. The question is, does the program require reform, and if so, what changes are coming?
Where Things Are Now
Social Security is a “pay as you go” system, with current income paying current payments. Payroll taxes of 12.4% (employees and employers each pay half, while self-employed workers pay the whole amount) support around 90% of benefits.
However, demographic trends indicate that the revenue stream is under threat, as the number of pensioners rises faster than the number of employees paying taxes. There were 3.4 employees for every Social Security recipient in 2000. Actuaries for the program predict that number will fall to 2.4 by 2030.
That implies more has to be raised from each worker, paid less to each recipient, or do a little of both.
A far lower portion of income is derived through taxes on Social Security benefits, which were initially implemented as part of a reform package in 1983. According to the Social Security website, around 40% of recipients pay taxes on a portion of their payments.
Increasing Payroll Taxes
The expected Social Security shortfall is around 3.4% of taxable payrolls. According to Alicia Munnell, the Center for Retirement Research at Boston College’s director, raising the payroll tax rate by 1.7% for employees and employers would allow everyone to receive full benefits for the next 75 years.
The maximum amount of salaries subject to Social Security payroll tax will increase from $147,000 to $160,200 in 2023. Rep. John Larson (D-Conn.) proposes reinstituting a payroll tax for incomes of $400,00 while simultaneously establishing a minimum payout of 25% over the poverty level. Currently, benefits are calculated based on your 35 highest-earning years, with no minimum.
Increasing the taxable base would increase revenues, especially if the payments didn’t result in extra benefits. However, Johnson is concerned that if it became a terrible deal for higher-income individuals, it would lead to less support for the program. What you receive has always been proportional to what you put in, and if politicians sever that relationship and Social Security is perceived as welfare, support may dwindle.
Increase the Taxable Wage Basis
The maximum wage amount subject to the Social Security payroll tax is linked to a national average wage index and adjusted yearly. The 9% increase for next year is based on the 2021 index, which was boosted when things returned to normal following the pandemic-related shutdowns of 2020.
According to Munnell, one option to increase revenue is to include employer contributions to employee healthcare insurance in the taxable salary base. According to Social Security actuaries, this would lower the 75-year deficit (the timeframe used to determine solvency) by nearly one-third. The plan would tax both employer and employee rates for employer-sponsored group health insurance, so both employees and employers would pay more.
Johnson believes this would make sense because when Social Security was created, practically all of the compensation came in wages, and today more of it comes in benefits.
Increasing the Full Retirement Age (FRA)
The FRA is the age at which you receive 100% of the guaranteed benefits. For most people, that’s 66 or 67. The age was raised from 65 to 67 during the 1983 reforms. Still, the adjustments weren’t implemented for 17 years “to give people time to adjust employment and savings behavior to the fall in benefits, according to Johnson. He also stated that the modifications to the FRA in 1983 resulted in a 12% reduction in benefits.
There has been discussion of increasing the retirement age to 69. That, however, would punish people with physically demanding professions who cannot work longer and may be forced to file for Social Security early. Many people file at the earliest age of 62, resulting in a 30% loss in compensation compared to waiting until FRA.
Rather than raising taxes, Andrew Biggs, a senior scholar at the American Enterprise Institute, advocates for measures that gradually reduce benefits for medium and upper-income workers while boosting them for lower-income earners.
“We’re a wealthy country, and it’s not unreasonable to expect Social Security to give a genuine guarantee against poverty in retirement years, which it now doesn’t since there’s no minimum benefit,” said Biggs. “At the same time, retirement savings outside of Social Security have increased considerably across all demographics, demonstrating that medium and upper-income individuals can and will save more for retirement on their own.”
What Happens Next?
Because there is little overlap between Democratic and Republican ideas for Social Security reform, Johnson believes a solution will be reached at the last minute. He thinks the most likely conclusion will be an increase in the taxable wage base and a reduction in benefits for the highest-income recipients.
According to him, part of the issue is that no one will be better off if you’re talking about fixing the program’s finances. So, you either reduce benefits or lower taxes, and neither is an achievement on which to run for reelection.
After entering the financial services industry in 1994, it was a desire to guide people towards their financial independence that drove Aaron to start Steele Capital Management in 2013. Armed with an extensive background in financial planning and commercial banking coupled with a sincere passion for helping people, Aaron has the expertise and affinity for serving the unique needs of those in transition. Clients benefit from his objective financial solutions and education aligned solely with helping them pursue the most comfortable financial life possible. Born in Olympia, Washington, Aaron spent much of his childhood in Denver, Colorado. An area outside of Phoenix, Arizona, known as the East Valley, occupies a special place in Aaron’s heart. It is where he graduated from Arizona State University with a Bachelor of Science degree in Business Administration, started a family, and advanced his professional career. Having now returned to his hometown of Olympia, and with the days of coaching his sons football and baseball teams behind him, he now has time to pursue his civic passions. Aaron is proud to serve on the Board of Regents Leadership for Thurston County as the Secretary and Treasurer for the Morningside area. His past affiliations include the West Olympia Rotary and has served on various committees for organizations throughout his community. Aaron and his beautiful wife, Holly, a Registered Nurse, consider their greatest accomplishment having raised Thomas and Tate, their two intelligent and motivated sons. Their oldest son Tate is following in his father’s entrepreneurial footsteps and currently attends the Carson College of Business at Washington State University. Their beloved youngest son, Thomas, is a student at Olympia High School. Focused on helping veterans and their families navigate the maze of long-term care solutions, Aaron specializes in customized strategies to avoid the financial crisis that care related expenses can create. Experience has shown him that many seniors are not prepared for the economic transition that takes place as they reach an advanced age. With support from the American Academy of Benefit Planners – an organization with expertise and resources on the intricacies of government benefits – he helps clients close the gap between the cost of care and their income while protecting their assets from depletion. Aaron can help you and your family to create, preserve and protect your legacy. That’s making a difference.
Investment advisory services are offered through BWM Advisory, LLC (BWM). BWM is registered as an Investment Advisor located in Scottsdale, Arizona, and only conducts business in states where it is properly licensed, notice has been filed, or is excluded from notice filing requirements. This information is not a complete analysis of the topic(s) discussed, is general in nature, and is not personalized investment advice. Nothing in this article is intended to be investment advice. There are risks involved with investing which may include (but are not limited to) market fluctuations and possible loss of principal value. Carefully consider the risks and possible consequences involved prior to making any investment decision. You should consult a professional tax or investment advisor regarding tax and investment implications before taking any investment actions or implementing any investment strategies.