Don't Count on Social Security Benefits

Physician's Money Digest, April30 2004, Volume 11, Issue 8

In making your retirement plan, whatshould you assume about SocialSecurity? Can you count on gettingany Social Security benefits at all? Let meoffer you a simplified explanation ofwhere we stand on the retirement part ofthe Social Security program.

Social Security History

From 1976 to 1982 the Social Securitysystem showed only small annual deficits,meaning Social Security taxes collectedeach year just about covered the paymentsmade that year. But nothing wasbeing saved and invested to pay futurebenefits. So it was clear that in the future,as the population grew older and theratio of retired to active workersinevitably declined because of demographictrends, it would be impossible tocollect enough Social Security taxes fromthe active workers to cover the paymentsto the retirees on this pay-as-you-go basis.

The Social Security Amendment waspassed in 1983 to solve the long-termproblem by gradually increasing both theSocial Security tax rate and the incomebase on which Social Security taxes are collected.The stated plan was that the excessof the annual collections over payoutswould be accumulated in the SocialSecurity trust fund and invested inTreasury bonds for use in the future whenannual payments started to exceed annualcollections. In concept this was a goodplan, and it made Social Security similar toprivate pension plans or individual 401(k)s.

Due to this change, since 1983 SocialSecurity tax collections have exceededannual payments by growing amountsevery year (eg, by about $160 billion in2003), and this is projected to continue inthe near future. By the end of 2003, theSocial Security trust fund had accumulateda balance of about $1.5 trillion. So whatexactly is this Social Security crisis we hearand worry about?

Social Security's Future

The problem is that the $1.5 trillion inthe Social Security trust fund is only anaccounting entry–or an IOU–from thefederal government. There is no realmoney in the fund because all of themoney has been spent to cover other governmentexpenditures and tax cuts overthe years. All the promises we have heardand will hear in the future about puttingthe excess Social Security money in a lockbox is just talk.

Up until 2018, if no changes are made,the annual collections will exceed annualpayouts, and the annual excess collectionswill continue to be spent to cover othergovernment expenditures or tax cuts. Thebook balance in the Social Security trustfund will grow significantly by then, butstill there will be no actual money in it.After about 2018, the annual payouts willstart to exceed the annual collection, andthe Social Security trust fund will have tostart cashing in some of the IOUs to keepup the payments.

That's when the real crisis will start.How will the government come up withthe money to pay the IOUs? It will have toraise Social Security or other taxes, cutback other expenses, or borrow themoney. It seems unlikely that the governmentwill be able to come up with all ofthe money it will owe the Social Securitytrust fund by then without seriously disruptingthe economy or other federal programs.What's more, even if the governmentpays back all of the money to thetrust fund when the money is needed, thetrust fund will still run out of money byabout 2040. After that, Social Security willnot be able to pay currently promisedbenefits in full unless Social Security taxesare increased significantly.

Although no cash flow crisis is expectedfor at least another 10 years, it isalmost certain that some importantchanges to Social Security will be made inthe next 5 to 10 years to reduce futurebenefits in some way. The reductions maybe in the form of means testing, higherretirement age, or lower cost-of-livingadjustments. There are other possibilitiesas well, all of which are equally unattractive.None of these changes bode well forthe future of Social Security.

Chandan Sengupta is the authorof The Only Proven Road toInvestment Success (John Wiley;2001) and Financial ModelingUsing Excel and VBA (John Wiley;2004). He teaches finance (ie,investment, business valuation, etc) at the FordhamUniversity Graduate School of Business and alsoconsults with individuals on financial planning andinvestment management. He welcomes questionsand comments at