Personal Finance

How Social Security funding affects your retirement

Retire well: Maximizing social security benefits
Retire well: Maximizing social security benefits

The first person to receive a monthly Social Security retirement benefit, Ida May Fuller of Ludlow, Vermont, earned quite a return on her tax dollars.

Fuller paid $24.75 in payroll taxes, which is used to fund Social Security, over three years while working as a legal secretary. She retired at age 65 in November 1939. On Jan. 31, 1940, she received her first Social Security check of $22.54. From then until 1970 when she died at age 100, Fuller collected a total of $22,888.92 in Social Security retirement benefits, according to the Social Security Administration (SSA).

Since Fuller got her first check, billions more have been sent out. This January, more than 42 million people received checks totaling $54.1 billion in monthly Social Security retirement benefits, according to the latest data from the agency. The average retired worker got a monthly benefit of $1,331. The maximum benefit a worker who retired at full retirement age can receive this year is $2,663 per month. (People who delay claiming their benefits can receive even more.)

But it's fair to wonder if those monthly payments will continue to come for future generations. If Congress does nothing, all of Social Security's trust funds are projected to be depleted by 2033. The SSA projects it will only have enough money from payroll taxes to cover three-quarters of the benefits it has promised retirees, according to the 2014 trustee's report.

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How did that happen?

Longer life expectancies have played a part in the shortfall. When President Franklin Roosevelt signed the Social Security Act into law in 1935, the average life expectancy was 61 years. The law set the full retirement age—the age to receive unreduced retirement benefits from Social Security—at 65.

Amendments to the Social Security Act signed into law by President Ronald Reagan in 1983, when the average life expectancy was 75 years, gradually raised the full retirement age from 65 to 67 for retirees. As it stands today, when the average life expectancy is 79 years old, anyone born in 1960 or later can receive full retirement benefits from Social Security at age 67.

Social Security faces another financial challenge from the retirement of the largest generation in U.S. history: the 76 million baby boomers born between 1946 through 1964.

By 2031, when the youngest boomers will have reached 67, an estimated 75 million Americans will be at least 65 years old, nearly double the number in 2008, according to a report by the National Academy of Social Insurance. The beneficiary-to-worker ratio, which compares the number of people drawing benefits to the number of workers who are paying into Social Security, will rise from 35 per 100 in 2012 to 46 per 100 in 2030.

Not surprisingly, younger workers are losing confidence that Social Security benefits will be a significant help for them in retirement. Only 19 percent of people in their 20s and 26 percent in their 30s told Gallup that they expect Social Security benefits to be a major source of income in retirement.

Overall, less than one-third of workers are counting on Social Security as a major source of retirement income, according to Gallup. And 46 percent of those surveyed by Gallup said they worry "a great deal" about Social Security.

Lawmakers have proposed raising the full-retirement age, reducing benefits for wealthier retirees (known as means testing) and raising payroll taxes. But these are just proposals, and nothing has come close to becoming law. The lack of clarity makes retirement planning difficult, especially for millennials and Generation X.

"Since nobody can guess how Social Security will turn out decades from now, we use planning tools and common sense to frame the discussion with younger people," said Jim MacKay, a certified financial planner in Springfield, Missouri.

Running the retirement numbers with different scenarios can help investors prepare for the worst.

"For folks that are a long way off from Social Security retirement benefits, the primary thing that I recommend when planning is to discount the potential value of benefits by at least 25 percent to account for future possible means testing, reductions across the board in benefit levels and increased taxability of Social Security benefits," said Jim Blankenship, a certified financial planner in New Berlin, Illinois.

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The scene is set for a political fight over Social Security next year. The trust fund for Social Security's disability benefits are projected to be depleted by late 2016. After that, the SSA estimates it will only be able to pay out about 80 percent of benefits to disabled people.

The Obama administration has proposed changing the formula of how payroll tax is split between Social Security's retirement and disability trust funds to increase the money that goes to the disability fund by about $330 billion over five years. The maneuver would mean both trust funds wouldn't be projected to be depleted until 2033. Previous Democratic and Republican administrations have made similar moves 11 times to fix shortfalls between the two trust funds. The last time such a tactic was used was in 1994 by the Clinton administration.

However, House Republicans passed a rule in February that prohibits transferring the money from the retirement trust fund to the disability fund unless Congress addresses the long-term funding of Social Security.

"The Obama administration has no solution except to take funds from Social Security itself. Social Security retirement funds have been raided far too many times for far too many years," said Rep. Tom Reed, R-N.Y., who co-sponsored the rule, in a statement.

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Whatever Congress does with Social Security retirement benefits between now and 2033, it will not affect younger savers for some time. It took 22 years for the 1983 amendments to the Social Security Act to phase in a modest bump to the retirement age.

At the least, the lead time on any new Social Security change should give younger generations plenty of room to plan for it.