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Social Security: CNBC Explains

Born out of the Great Depression, Social Security is a\) a socialist-styled government giveaway costing billions, or b\) a well-thought-out retirement plan for aging citizens, paid mostly with their contributions.

Either way, the program has been a source of controversy since the beginning.

But what is the truth behind Social Security? What was it meant to do and how has it changed over the years? CNBC explains.

What is Social Security?

Social Security is a mandatory retirement system established in 1935 as part of President Franklin D. Roosevelt's New Deal. It is run by the Social Security Administration, or SSA, based in Woodlawn, Maryland, just outside Baltimore.

The agency includes 10 regional offices, eight processing centers, some 1,300 field offices, and 37 Teleservice Centers. About 62,000 people work for the SSA.

The Social Security Act—as it is formally known—was created out of the devastating effects from the Great Depression. Millions of Americans lost their jobs, savings disappeared and the elderly were often left without a source of income.

The SSA provides benefits to retirees and disabled workers.

It is a “pay-as-you-go” program in which current workers fund benefits for current retirees and disabled Americans. In most cases, a worker must have 10 years of covered employment to be eligible for retirement benefits.

In 2011, there are an estimated 56 million people receiving Social Security benefitsand 158 million workers paying into the system.

The act has expanded over the years, as we'll see later. It also gives money to states to provide assistance to Aid to Families with Dependent Children, Maternal and Child Welfare, public health services, and the blind.

How is Social Security funded?

Workers and employers pay for Social Security—in fact, both are required to pay Social Security taxes.

In 1935, the amount employers and workers paid was a combined 2 percent payroll tax on the first $3,000 of a worker's income.

As of 2011, workers paid 6.2 percent of their earnings into Social Security—up to an income of $106,800 a year. After workers hit that income level, taxes are no longer deducted.

Employers pay a matching amount, for a combined contribution of 12.4 percent of earnings.

Self-employed persons have to pay both the employee and employer share—for a total 12.4 percent.

Another source of funds comes from higher-income Social Security beneficiaries, who pay federal income taxes on their benefit income.

One important note: Social Security is not technically part of the federal budget. It never has been. In 1968, President Lyndon Johnson included Social Security for the first time in a "unified federal budget" as part of an effort to end confusion over budgetary procedures.

It was taken 'off budget' by 1986—meaning its balance sheet is not technically part of the overall federal budget.

However, those involved in federal budget matters often produce two sets of numbers, one without Social Security included in the budget totals and one with it included.

How are benefits calculated?

This is not the easiest of math problems to solve, as even the SSA admits.

Social Security benefits are based on a worker's lifetime earnings. Out of entire earnings from age 22 to 62, the highest 35 years of indexed earnings are used in the computation.

Actual earnings are adjusted or "indexed" to account for changes in wages since the first year of work.

The purpose for indexing earnings is to make sure benefits reflect the rise in the standard of living that took place during a worker's lifetime. Benefit increases are based on annual cost of living allowances—what's referred to as a COLA.

The average monthly Social Security benefit for a retired worker was about $1,177 at the beginning of 2011, according to the SSA.

The SSA had send out by mail twice a year estimated benefits recipients would get. However, in a recent cost cutting move, that mailing has stopped.

The SSA has an online benefit calculator.

Are Social Security benefits taxed?

Yes. Until 1984, Social Security benefits were exempt from taxes. But in 1983, Congress made up to 50% of Social Security benefits taxable for higher-income beneficiaries; and in 1993, up to 85% was made taxable.

According to the Congressional Budget Office, about 40% of beneficiaries are impacted by the tax.

But the taxes collected are credited to the Social Security Trust Funds and the Medicare Hospital Insurance Trust Fund and not used for the Federal budget.

What is the Social Security Trust Fund?

Actually, there are twotrust funds to handle surpluses in the program. Both were started in 1939.

The Social Security Trust Funds are: the Old-Age and Survivors Insurance (OASI) and the Disability Insurance (DI) Trust Funds. These funds are accounts managed by the Department of the Treasury.

They serve two purposes: they provide an accounting mechanism for tracking all income to and out of the trust funds—and most importantly, they hold the accumulated assets.

Social Security surpluses are, by law, invested in U.S. Treasury securities. When payroll taxes exceed benefits in a particular year, the surpluses are used to buy securities which are held by the Trust Funds.

The Trust Funds earn interest, which is set at the average market yield on long-term Treasury securities. Interest earnings on the invested assets of the combined OASI and DI Trust Funds were $2.6 trillion by 2010.

So far, there have been 11 years in which the Social Security program did not take in enough FICA taxes to pay the current year's benefits.During that time, Trust Fund bonds in the amount of about $24 billion made up the difference.

Social Security’s costs will grow in coming years as the large Baby Boom generation those born between 1946 and 1964—move into their retirement years. The trust funds would then be exhausted by 2037 without changes to the system.

What age do you have to be to collect Social Security?

The first checks went to those who reached age 65, though early retirement at 62 would bring limited benefits, with a permanent reduction to 80 percent of the full benefit amount.

But the age has increased. In 2010, the full benefit age became 66 for people born in 1943-1954, and it will gradually rise to 67 for those born in 1960 or later.

Early retirement benefits will continue to be available at age 62, but they will be reduced more.

When the full-benefit age reaches 67, benefits taken at age 62 will be reduced to 70 percent of the full benefit and benefits first taken at age 65 will be reduced to 86.7 percent of the full benefit.

What are the origins of Social Security in the U.S.?

The U.S. created several pension plans for soldiers and sailors through its early history. But fast forward to the Civil War, and we find the first true government relief program that could be called a social security system, according to the SSA.

The Civil War Pension Program was signed into law in 1862 and provided funds to U.S. soldiers who were disabled in battle. Widows and orphans could receive pensions equal in amount to what would have been paid to a surviving veteran.

By 1890, the law changed so that any disability—from battle or not—would qualify a vet for funds. In 1906, old age was made a sufficient qualification for benefits. One note: pensioners did not have to pay into the system to receive funds.

Leaping into the 20th century and again to the Great Depression, we come to Social Security's true start. What's interesting to note is that several states at that time, such as New York and Massachusetts, passed limited pension plans for the elderly before the federal government did.

In June 1934, FDR announced his intention to provide a social security program. He created the Committee on Economic Security to come up with the exact plans for the system.

FDR submitted a bill with the recommendations, and it eventually passed both houses of Congress and was signed into law on Aug. 14, 1935.

How has Social Security expanded?

Initially, the SSA was charged with providing benefits only to retirees and some unemployed people.

The benefits for retirees was not supposed to be permanent. It was to be a temporary "relief" program that would eventually disappear as more people were able to obtain retirement income. And there were limits on the unemployed. Job categories not covered by the initial act included workers in agriculture, domestic service, government employees, and many teachers, nurses, hospital employees, librarians, and social workers.

A 1939 change in the law added survivors' benefits and benefits for the retiree's spouse and children.

By 1950, Social Security laws expanded coverage to all non-government workers, including the self-employed. It wasn't until 1983 that civilian federal workers—such as the President of the United States—were eligible for Social Security benefits.

Another change to Social Security was the addition of Disability Insurance program in 1956. This provides monthly cash benefits for disabled workers and their dependents who have paid into the system, and met minimum work requirements.

An important note of change involves Medicare and Medicaid. Medicare is the nation's health insurance program for people age 65 or older; Medicaid is a health and medical services program for low income individuals and families. Both were established in 1965 under a Social Security reform law.

But they are not a direct part of Social Security. Like Social Security, Medicare is financed by a portion of the payroll taxes paid by workers and their employers. But Medicare is also financed in part by monthly premiums deducted from Social Security checks.

What is the basis of your Social Security number?

Ever wonder why the Social Security numbers are the way they are?The numbers are designed to make sure benefits are accurate.

The first three digits are assigned by the geographical region in which the person was residing at the time they obtained a number.

Generally, numbers were assigned beginning in the northeast and moving westward. So people on the east coast have the lowest numbers and those on the west coast have the highest numbers.

The remaining six digits in the number are more or less randomly assigned and organized to ease bookkeeping procedures.

And by the way, no serial number 0000 has ever been assigned. Social Security numbers were first issued in November 1936. To date, 453.7 million different numbers have been send out.

When a Social Security card holder dies, that number is not reused.

What is the controversy surrounding Social Security?

Often called the “third rail” of American politics, Social Security has been attacked from both sides of the political spectrum.

Big business opposed Social Security from its beginning because it imposed new taxes, new bookkeeping requirements, and"undermined the absolute dependence of the employees on the company."

Many on the left said it didn't go far enough to help citizens and was discriminatory—nearly two-thirds of all African Americans in the labor force and just over half of all women employed were not covered by Social Security at its inception.

There have been calls for many changes over the years: raise the retirement age, reduce benefits, and privatize the SSA by transferring the funds held by the government to Wall Street investment firms.

The impact of Social Security may be underlined by the fact that 8 percent of the elderly receiving Social Security benefits are poor, according to U.S. government standards. Meanwhile, forty-eight percent of Americans would be below the poverty line if they didn't receive a monthly Social Security check, according to government statistics.

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