3 Reasons Social Security Is Struggling and 6 Things That Could Fix It

It’s no secret that Social Security isn’t doing well, but most people tend to overestimate the severity of the situation. They believe Social Security will disappear in a few years, leaving them to fully fund their retirements.

Fortunately, that won’t happen. But the reality is still quite worrying. Social Security’s trust funds will be exhausted in 2034, according to a recent Congressional Budget Office (CBO) report. Without government intervention, recipients would immediately face 23 percent cuts to their checks.

Image source: Getty Images.

Fixes are possible — perhaps even — but they come at a high price. If you’re already on Social Security or plan to rely on it in the future, understanding this crisis and possible ways out of it are essential to preparing for the changes these reforms may have on your finances.

How does social security get its money

Social Security’s funding crisis is a multifaceted problem, but it goes back in large part to changing societal demographics. To understand this, it’s important to mention how Social Security gets its money in the first place. There are three sources of income:

• Taxes on social security wages: That’s the 12.4 percent tax, split equally between employee and employer, that all workers pay on the first $168,600 they earn in 2024. It provides most of the program’s funding and brought in more than 1.23 trillion USD in 2023.
• Interest on social security trust funds: In the past, when Social Security tax revenue exceeded spending, the excess money went into a trust fund where it was invested in government-backed securities. Interest earned on these investments generated nearly $67 billion for the program last year.
• Taxes on social security benefits: Up to 85 percent of seniors’ Social Security checks are now subject to ordinary income tax if their provisional income—adjusted gross income (AGI) plus tax-free interest from their investments and half of their annual Social Security benefits—exceeds $25,000 for a single adult. or $32,000 for a married couple. These taxes provided nearly $51 billion in revenue last year.

Thanks to these revenue sources, Social Security will collect more than $1.35 trillion in 2023 — but it’s not enough. Program spending was nearly $1.4 trillion last year and will only increase as the 2025 cost-of-living adjustment increases benefits and increases program spending.

So far, the Social Security Administration has been able to make up for this shortfall by withdrawing money from trust funds, but that won’t work forever.

Year-End US Old-Age and Survivors Trust Fund Assets by YCharts

Trust fund reserves are dwindling, and when they are gone, Social Security will only be able to pay what it takes in payroll and benefit taxes.

Three Reasons Social Security Taxes Don’t Cut It

For many years, Social Security taxes were more than adequate to fund the program. But several key changes in recent decades have made this approach unsustainable:

1. Retirement of baby boomers: Baby boomers held the title of the largest generation for decades, and that was great news when they were in the workforce because it kept the worker-to-earner ratio high. But as baby boomers retired, Social Security had to pay out higher and higher amounts to cover all their benefits.
2. Increased longevity: Average life expectancy in the U.S. has been rising for decades, at least until recent years when issues like the COVID-19 pandemic hit. Longer lives mean more years spent claiming Social Security benefits, which means more beneficiaries claiming at once than in the past.
3. Declining birthrate: The birth rate for US women in 1960 was 3.7. That number has dropped to 1.7 by 2022. That means fewer workers have replaced retiring baby boomers in paying Social Security taxes, leading to lower revenue for a program that pays benefits to a growing number of seniors.

Unfortunately, there is nothing anyone can do to change these problems. That leaves only one option: Change Social Security to accommodate them.

Six Potential Social Security Fixes

There are essentially two ways to fix Social Security, and both have their drawbacks. The first option is for the government to increase its tax revenue. It could do this in a few ways:

1. Increase in the social insurance payroll tax rate: The recent CBO report indicates that permanent growth of 4.3% would be needed to combat the funding shortfall. That would cost someone making $60,000 a year an additional $2,580 annually.
2. Increase in the tax rate of social security benefits: This would reduce the benefits available to seniors to cover their living expenses.
3. Raising the income ceiling subject to social security taxes: This would raise or eliminate the Social Security payroll tax cap ($168,600 in 2024). It is the most popular of the tax hike proposals because the burden of paying more falls on the wealthy. However, this would not be enough to solve the deficit on its own. A recent study by the University of Maryland estimated that it would only reduce the deficit by 60%.

The other way to solve this problem is to reduce benefits. Again, there are a few options here:

1. Reduce benefits for everyone: The CBO report estimates that a 24 percent cut in benefits would be needed to fix the shortfall. This would drop the average benefit from $1,920 per month from August 2024 to $1,460 per month.
2. Reduce annual cost of living adjustments (COLAs): These are increases that occur most years to help counter inflation. Many argue that COLAs are already inadequate, causing purchasing power to decline.
3. Raising the full retirement age (FRA): The full retirement age (FRA) is 67 for most workers today, although some older adults have FRAs up to 66. You can claim benefits before you reach FRA, but doing so will cut your checks by up to 30%. Increasing the FRA would subject more workers to these early claim penalties and make these penalties even more severe than they currently are.

There are no easy solutions and that is why the government has done nothing yet. Someone is going to be unhappy no matter what they decide. In all likelihood, the government will not choose one of these solutions alone. It will probably take a combination of these and possibly other strategies to fix it.

If there’s one takeaway for workers and retirees, it’s that reducing your reliance on Social Security is the best way to ensure a comfortable retirement. It’s easier said than done, but if you can diversify your retirement income and maximize your annual retirement savings, you’ll be less affected by whatever the government decides.