Social Security – Too Much to Retirees?

2024 will likely be another year of wrangling over government expenditures by Congress. Social Security is the largest government expenditure and expected to grow in the future due to the aging of the American population. Does Social Security pay too much to retirees? This blog provides a quick example of what Social Security typically pays to a retiree relative to the financial amount available if the government had invested applicable payroll taxes for the benefit of the retiree.

Social Security programs are funded through payroll taxes. Employees and their employers each pay 6.2% of earnings for Social Security taxes; an additional 1.45% of earnings are paid for Medicare taxes. In sum, a total of 15.30% of an employee’s earnings are subject to Social Security and Medicare taxes, with employee and employer each paying 7.65% of an employee’s earnings. There is a salary limit for Social Security taxes. The salary limit was $160,200 in 2023 and will be $168,600 in 2024, with the salary limit typically adjusted each year by the approximate level of inflation. (There is no salary limit for Medicare taxes.) Earnings exceeding the salary limit are not subject to Social Security taxes. The formula to determine your Social Security benefit is a function of the payroll taxes paid to Social Security. If you are thinking that the money you paid into Social Security by you and your employer will be there for you when you retire, alas, it’s not. Current payments into Social Security are being dispersed to those receiving benefits now – any excess payments remain in Social Security trust funds.

In 2021, Social Security’s total cost exceeded its total income (payroll taxes) for the first time since 1982. Disbursements are expected to continue to exceed program income for the foreseeable future, with money drawn from the trust funds to pay the difference. Current payments into Social Security being dispersed to current beneficiaries set the stage for financial difficulties when the demographics of the U.S. shifted to an aging population. By 2033, it is expected Social Security will only be able to pay 77 percent of scheduled benefits to retirees, unless something changes. The 2023 average monthly Social Security benefit for retirees was only $1,827. 

A simple numerical example demonstrates what should be available for retirement income, based on paying payroll taxes each year if those payroll taxes were invested for the taxpayer’s benefit. The example also illustrates that Social Security does NOT provide excessive monthly income to retirement beneficiaries. Social Security theoretically assures workers of a retirement income.

Assumptions:

• An individual starts working in 1983.
• The individual works for 40 years and retires in 2023.
• The individual and employer paid the applicable amount in payroll taxes each year.
• The individual earns the median household income in 1983, which was $24,580.
• Assumed annual income increase: 2% (This would yield an income high of $53,209 in 2022.)
• Annual percentage yield (APY) on invested payroll taxes: 4%.  (The 4% return is a conservative assumption; the long-run average return on long-term government bonds is almost 6% while the average return on large company stocks is almost 12%.)

Retirement Income based on Assumption:

• Amount available for retirement in 2023: $392,820.
• If the individual has a life expectancy of 20 years, a monthly benefit of approximately $2,365 would be provided by the retirement savings. This compares to the 2023 average monthly Social Security benefit of only $1,827.

Social Security is certainly not overpaying retirement income to beneficiaries based on the payroll taxes collected from those beneficiaries. The aging of the American population, combined with the funding methodology where current payroll taxes are used to fund payments to current beneficiaries, has created the Social Security financing problem.

There are other options rather than simply cutting benefits to financially stabilize the Social Security system. Options include reducing costs through operational restructuring, limiting Social Security payments based on income or wealth, increasing payroll taxes, and/or eliminating the payroll tax cap. For example, the Congressional Budget Office estimates that subjecting earnings above $250,000 to the payroll tax in addition to those below the current taxable maximum would raise more than $1 trillion in tax revenues over a 10-year period. (Total Social Security disbursements were approximately $1.24 trillion in 2022, slightly greater than program income of $1.22 trillion.) Like almost any policy, there are pros and cons to every option. But the Social Security financing problem should be constructively analyzed and solved. A combination of options could be used to solve the Social Security financing problem.

In 2021, Social Security’s total cost exceeded its total income for the first time since 1981. In response to funding concerns,  a variety of changes occurred under President Reagan, including increased payroll taxes, making Social Security payments subject to taxation, and raising the retirement age for full benefits in the next century.

Social Security remains vitally important to Americans. According to the most recent Survey of Consumer Finances by the Federal Reserve, approximately one-third of Americans have no retirement plan other than Social Security. Social Security has also played a major role in reducing poverty for those aged 65 and over. According to the U.S. Census Bureau, in 1959 the poverty rate for Americans aged 65 and over was 35.2%; in 2022 the poverty rate for Americans aged 65 and older was 10.2%.

For further information:

1. From the Peter G. Peterson foundation:
   • Should We Eliminate the Social Security Tax Cap? Here are the Pros and Cons
   • What Effect Does Social Security Have on Poverty?
2. From the Congressional Budget Office: Options for Reducing the Deficit
3. From the Federal Reserve: Changes in U.S. Family Finances 2019 – 2022 (Survey of Consumer Finances)
4. From the U.S. Census Bureau: Historical Poverty Tables
5. From the Social Security Administration: Social Security Administration (SSA): Social Security History