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The Social Security Program in the U.S.A. –
How it works
Editor’s Note: The following information is
from the Social Security Sourcebook published by the non-profit,
non-partisan National Academy of Social Insurance for 2005. It provides a solid,
unbiased explanation of the Social Security program and its finances. To
visit their site, which also has information on Medicare, Workers
Compensation and Unemployment Insurance,
click here.
May 9, 2005 – Social Security is the nearly
universal retirement program for Americans, with about 92 percent of
people aged 65 and over receiving benefits. About 156 million Americans
pay Social Security taxes and about 47 million collect monthly benefits.
A worker can collect early retirement benefits at
age 62 and full benefits at age 65 and six months. The age for full
benefits is gradually increasing and will reach age 67 for those born in
1970 or later.
The maximum benefit for a worker retiring in
January 2005 is $1,939 a month.
The average benefit in January 2005 was:
$955 a month for all retired workers;
$1,574 a month for a married couple over the age of 65;
$920 a month for a widow or widower over the age of 65;
$895 a month for a disabled worker;
$1,497 a month for a disabled worker, spouse and one or more children;
$1,979 a month for a widowed mother and two children.
Beneficiaries include 37.7 million people over the
age of 62 drawing retirement benefits. About 65 percent of all
beneficiaries age 65 and over depend on Social Security for more than
half of their total income
Social Security is the only source of retirement
income for 20 percent of all people age 65 and older. For various groups
within this population aged 65-plus, Social Security is the sole
provider of retirement income for 41 percent of Hispanics, 40 percent of
African Americans, 29 percent of unmarried women and 28 percent of Asian
and Pacific Islanders.
The
Finances
Social Security is financed through a tax on
workers’ earnings up to $90,000 a year (the figure for 2005; it rises
each year). The worker and the employer each pay a tax of 6.2 percent,
for a total of 12.4 percent. For example, the average worker makes
$34,700 a year, according to the Social Security Administration. This
worker pays $2,151.40 a year, or 6.2 percent of salary, and the employer
pays an identical amount. Their combined taxes are $4,302.80
In 2003, Social Security trust funds received
$631.9 billion in income and spent $479.1 billion for benefits and
administrative costs. The surplus funds are invested in special issues
of US Treasury securities. What happens to the extra money collected by
the Social Security system? In effect, it is loaned to the Treasury,
which is borrowing the money just as it borrows money when it sells
Treasury securities to the public. In this sense, the surplus money
collected by Social Security helps pay for the rest of the government.
In return for the surplus tax revenues it furnishes
to the Treasury, the Social Security trust funds receive Treasury
securities bearing a market rate of interest. The average interest rate
on this portfolio held by the Social Security trust fund is about 6
percent.
The federal government is spending the cash it
borrows from Social Security, and that makes “some people see the
current increase in the trust fund assets as an accumulation of
securities that the government will be unable to make good on in the
future,” according to the Social Security Administration. But, the
agency says on its website, “Far from being ‘worthless IOUs,’ the
investments held by the trust funds are backed by the full faith and
credit of the U. S. Government. The government has always repaid Social
Security, with interest. The special-issue securities are, therefore,
just as safe as U.S. Savings Bonds or other financial instruments of the
Federal government.”
The Trustees’ best estimate of the future of Social
Security is called the intermediate projection. The forecast includes
estimates of the growth in the economy, the number of immigrants, and
the estimates of longevity for the aging population. The trustees
forecast that payroll tax revenue from workers and employers flowing
into the trust funds will exceed benefits until the year 2018.
After that, Social Security, instead of
contributing a surplus to the federal coffers, will begin making the
federal budget deficit larger. Social Security’s gap between tax
revenues and spending “will be covered with cash from redeeming special
obligations of the Treasury, until these assets are exhausted in 2042,”
according to the Social Security Administration. The cash to redeem the
bonds may come from several sources: increased taxes, reductions in
other federal government spending programs, or borrowing through the
public sale of Treasury seciurities. If the money is borrowed, it will
increase the federal budget deficit.
Under the trustees best estimate projection, by
2042, the payroll taxes flowing into the system will be sufficient to
pay only 73 percent of benefits promised under current law. And by 2078,
at the end of the 75-year projection period used by the Social Security
Trustees for their long-range forecast, tax revenues are projected to
cover about 68 percent of scheduled benefits.
The overall cost of Social Security is going to
increase faster than the program's income because of the aging of the
baby-boom generation, expected continuing low fertility, and increasing
life expectancy. By 2031, there will be almost twice as many older
Americans as there are now, with the number rising from 37 million now
to 71 million. There are currently 3.3 workers for each Social Security
beneficiary. By 2031, there will be 2.1 workers for each beneficiary.
Beneficiaries are living longer, which means more years in which they
will collect benefits. When the Social Security program was created in
1935, the life expectancy of a 65-year-old was 12˝ years. Today, it is
17˝ years.
The fiscal strain will come from the aging and
retirement of the baby boomers, the biggest generation in American
history; these are the people born in the years 1946 through 1964. For
all these reasons, Social Security faces a long-range gap between its
revenues and its spending. One way to look at this is in context of the
entire economy. Social Security now consumes 4.3 percent of the nation’s
total economic output, called the Gross Domestic Product (GDP). If the
entire US economy is represented as a dollar bill, Social Security costs
a little more than four cents. Social Security tax revenues are 4.9
percent of the GDP. The difference reflects the fact that Social
Security taxes now exceed benefits so the system is building reserves.
By the year 2030, when the youngest of the baby
boomers will have turned age 65, Social Security is projected to cost
more than six cents of the dollar, or 6.3 percent of Gross Domestic
Product. That is an increase of 1.4 percentage points over what we are
paying today in taxes.
How does that compare with past changes in national
spending when the baby boomers were children? Public spending for
education by local, state and federal governments grew about twice as
much as the projected increase in Social Security. Public spending for
education was 2.3 percent of the GDP in 1950, just before the boomers
began entering kindergarten, and it grew to 5.2 percent of GDP by 1975,
an increase of 2.9 percentage points over 25 years. In 1960, every 100
workers supported 262 persons in total, the combination of children,
workers, retirees, and other adults not in the work force. This declined
to 200 persons for every 100 workers in 1995, after the boomers had
grown up and joined the work force. The support burden will rise to 221
persons per 100 workers by the year 2030 with the boomers in retirement.
Social Security has a solvency problem, and the
different ways to close the gap include increasing revenues or reducing
spending, or a combination of both steps.
Solvency Solutions
At one extreme, the solvency problem could be
solved strictly through taxes. The Social Security Trustees, in the 2004
report, say that Social Security could be made financially stable for
the next 75 years by an immediate increase in taxes, raising the rate to
14.29 percent from the current level of 12.4 percent. For the average
worker, earning $34,700, this would mean an immediate and permanent tax
hike of $329.65 a year, raising his or her taxes from the current level
of $2151.40 to $2481.05. The employer would face an identical increase.
For the worker now at the maximum taxable wage of $90,000, there would
be a tax hike of $855 a year for the worker, and an identical amount for
the employer. The tax paid for a maximum earner, would rise from the
current level of $5,580 to $6,435. Combined taxes paid by worker and
employer would rise from $11,160 to $12,870.
At the other extreme, the financing gap could be
solved strictly with benefit cuts. The trustees say an immediate
reduction of benefits by 12.6 percent would put the trust fund on sound
footing for 75 years. This means the average retired worker, currently
receiving $11,460 a year from Social Security, would face a cut of
$1,443.96 a year, lowering the annual benefit to $10,016.04. (In monthly
terms, the benefit would drop from $955 to $834.67). The average married
couple over the age of 65, now receiving $18,888 a year, would face a
benefit cut of $2,379.88, lowering their combined checks to $16,508. (In
monthly terms, the benefit would decline from $1,574 to $1,369.38.)
There is no political enthusiasm for any solution
that depends exclusively on either raising taxes or cutting benefits.
Most solvency proposals are likely to include a combination of revenue
increases and benefit reductions.
Personal Accounts
Supporters of the traditional Social Security
program point to its long record of success in providing a basic income
for people in retirement. They argue that the problem is manageable and
that it can be handled through incremental steps. They also point out
the inaccuracy of 75-year projections upon which the solvency problem is
based.
On the other hand, advocates of private accounts
contend that Social Security should be changed to allow individuals to
retain a portion of their payroll taxes and invest the money. These
personal accounts would provide a better retirement income in the long
run for younger workers, according to the advocates of private accounts.
A Commission appointed by President Bush in 2001 studied the issue and
discussed a voluntary plan under which workers (below the age of 55)
would keep two percentage points of their 6.2 percent payroll tax and
invest the money in personal accounts.
The creation of individual accounts would shift
employee contributions out of Social Security that are needed to pay
benefits for those who are retired or about to retire in coming decades.
Shifting Social Security funds to individual accounts does not remedy
the solvency problem. Instead it hastens the day when funds are
insufficient to pay scheduled benefits.
Distributing Money From Private Accounts
The creation of personal accounts raises separate
issues from the solvency question. Many of the key issues focus on the
complexities of distributing money amassed in personal accounts.
Here are some of the key issues: How much access
could retirees have to their account funds? Would they be allowed to
take lump sums when they retire, or would they be required to buy
annuities, insurance contracts that guarantee monthly payments for life?
Would people be allowed to withdraw funds or borrow
against the personal accounts before retirement age, as they can now
with 401(k) savings plans? Do the answers change if the worker becomes
disabled or dies before retirement?
What rights would a spouse or former spouse have to
the accounts? Would accounts be divisible property at divorce? Would
spousal rights be decided in federal law or in family law that differs
from state to state?
These issues are discussed in a NASI report,
Uncharted Waters: Paying Benefits from Individual Accounts in Federal
Retirement Policy.
The report provides some estimates on the size of
individual accounts.
This example looks at an individual account in
which the worker can place two percentage points of the 6.2 percent
Social Security payroll tax. Someone earning $34,700, the average annual
wage, could put $694 a year into the investment program.
Most personal accounts proposals call for investing
the money into a selection of index funds similar to the mutual funds
available to federal workers under the government Thrift Savings Plan
(TSP).
A low earner making $15,600 a year would have a
balance at age 65 after 20 years of work of $9,400. An annuity purchased
with this account balance would yield $55 a month. Someone working 40
years at the low-wage level would have $26,700 for the annuity,
producing $150 a month.
A medium earner with average lifetime earnings of
$34,700 years would have a balance of $21,000 in an account after 20
years. (This assumes a rate of return 4 percent above the rate of
inflation.) At age 65, the individual could purchase an annuity that
provided an income of $125 a month. If the individual worked 40 years,
the account balance would be $59,300 and produce an income of $333 a
month.
A higher earner making $55,500 a year would have a
balance of $33,300 after 20 years. This could buy an annuity producing
income of $195 a month. Working for 40 years would produce a personal
account balance of $94,900, sufficient for an annuity producing income
of $536 a month.
What is Social
Insurance?
Life is filled with risks. Uncertainty is the rule
because nobody can predict with confidence his, or her, future state of
wealth or health. Families once bore the primary responsibility for
caring for their individual members in bad times. But modern industrial
society has scattered family members to different jobs in different
locations. There are certain risks we have agreed to confront as a
society, rather than as individuals. Citizens have decided, through the
political system, that we need protection against some of life's
difficulties that are hard to face as individuals. These include old
age, ill health, unemployment, disability that makes it impossible to
work, injury on the job, and the death of a family breadwinner. For all
these conditions, we rely on help from social insurance programs, which
are financed by workers and employers.
Social insurance programs include Social Security,
which pays benefits to retired workers and disabled workers and their
families; Medicare, which pays for health care for those over 65 and the
disabled of all ages; Workers' Compensation, which pays for wage
replacement and medical costs for those injured on the job; and
Unemployment Insurance, which provides partial wage replacement for
those who have lost their jobs.
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