The Social Security Administration has confirmed that beneficiaries will see an increase in their checks starting January 2025. This adjustment, known as the Cost-of-Living Adjustment (COLA), is intended to ease the burden of inflation on the finances of retirees and other recipients. While the exact percentage of the increase will be announced on October 10, this adjustment is expected to provide some short-term financial relief.
However, concerns about the long-term sustainability of the system remain significant, particularly for those expecting to rely on these benefits over the next decade or more. Since 2021, Social Security has been paying out more money than it has been receiving in revenue, leading to a growing shortfall. To make up for this deficit, the program has been drawing from its remaining reserve funds. Unfortunately, these funds are not unlimited.
The uncertain future of Social Security
A recent report from the Congressional Budget Office (CBO) indicates that the Old-Age and Survivors Insurance (OASI) Trust Fund could run out of money by 2033. This fund is responsible for retirement and survivor benefits, while the Disability Insurance (DI) Trust Fund could last until 2064.
One proposed solution to extend the life of these funds is to combine them. If that happens, both funds are projected to run dry by 2034. This critical situation arises largely because Social Security spends significantly more on pensions and survivor benefits than it does on disability benefits. If no action is taken soon, by 2035, beneficiaries may face a reduction of up to 23% in their monthly checks, and the situation could worsen through 2098, when an additional 5% cut could be implemented.
How these cuts will affect retirees
A 23% cut in benefits would be a severe blow to millions of retirees, especially for those who rely heavily on Social Security for their income. For example, if the current average retirement benefit is $1,920 per month, a 23% reduction would mean retirees would receive roughly $1,478 per month. This decrease of about $5,300 per year could significantly impact the quality of life for many older individuals, making it difficult to cover basic living expenses.
It’s clear that Social Security is facing a major challenge, and any solution will likely need to balance the interests of multiple generations of workers and retirees.
What can be done to avoid these cuts?
The good news is that it is unlikely the government will allow benefits to be reduced so drastically. In the 1980s, Social Security faced a similar financial crisis, and changes were introduced that largely preserved the structure of benefits. However, those changes did not come without sacrifices.
Some of the modifications made
Raising the full retirement age (FRA): The age at which beneficiaries can receive their full benefits based on their work history was increased. While people can still apply for benefits earlier, doing so reduces the amount they receive each month. This change particularly affected younger workers, who face larger penalties for claiming benefits before reaching their full retirement age.
Increasing the Social Security payroll tax: All workers must pay a payroll tax on their earnings to fund Social Security, up to a limit adjusted annually for inflation (in 2024, this cap is set at $168,600). The current rate is 12.4%, split between employers and employees. Raising this tax reduces workers’ take-home pay.
Taxing certain Social Security benefits: Some retirees are required to pay taxes on their Social Security benefits if their provisional income exceeds certain thresholds ($25,000 for individuals and $32,000 for married couples). This tax burden reduces the amount available to retirees for covering their living expenses.
Solutions that could be adopted in the future
These measures from the 1980s could serve as inspiration for current discussions on how to solve Social Security’s financial challenges. In fact, the CBO report suggests that to fully address the funding shortfall, either a 4.3% increase in the payroll tax or a permanent 24% reduction in benefits would be necessary. However, given the economic impact of such measures, the final solution will likely involve a combination of approaches.
For example, a moderate increase in the payroll tax could be implemented alongside higher taxes on the benefits of wealthier retirees. This would distribute the financial burden more evenly across different groups, preventing any one sector of the population from shouldering the entire weight of the shortfall.
It’s crucial that decisions are made soon to ensure that Social Security can continue to provide financial support to future generations without jeopardizing the financial stability of current retirees.
As lawmakers and policymakers debate possible solutions, several ideas are being considered. One potential approach involves raising the cap on taxable earnings, meaning higher-income workers would contribute more to Social Security. Another option is adjusting the formula used to calculate COLA to better reflect the costs faced by retirees, such as healthcare expenses. Additionally, there are proposals to gradually increase the full retirement age again, reflecting longer life expectancies.
Regardless of the specific measures taken, it’s clear that a mix of revenue increases and benefit adjustments will likely be necessary to preserve Social Security’s solvency. Finding a balance that protects the most vulnerable retirees while ensuring long-term stability for the system as a whole will be the key challenge.