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Tuesday, June 7, 2022

Social Security’s Trust Fund Woefully Underperforms

Every cent of your Social Security trust fund is invested in low-yielding government bonds. Is this fair?  

Back in 1935 when Social Security was enacted, America was in the throes of the Great Depression. The country had no appetite for stocks. Franklin Roosevelt was desperate to find a way out, and his New Deal needed financing. Killing two birds with one stone, policymakers voted to invest workers’ retirement funds exclusively in safe government securities. 

The program was financed on a pay-as-you-go system until 1977, when legislation called for the accumulation of large reserves. These reserves totaled $741 billion by the end of 1998 and continued to increase until recently. This massive sum was still bound by law to be invested entirely in low-yielding special Treasury issues. The fund pays out about 22% of current Social Security checks, and it is projected to run dry by around 2033. 

Investment Performance

How much are all those FICA (Federal Insurance Contributions Act) taxes you paid earning? In April, they were invested in notes that earned 2.5% interest. You might have heard that inflation is running a hot 8.5% this year, which means that all that money is losing 6% per year. In 2021, consumer prices rose 7%. How much interest did Social Security dollars earn that year? Get ready … 1.4%. It is not hard to see why the fund is in a meltdown.

Population Demographics Tip the Scales

America’s population is getting older. People 65 and over comprised 16.5% of the total in 2021, and that number is projected to grow. That means less youngsters paying into Social Security, and more folks relying on it for a check. Why is that changing?

Back when Social Security was created, families had more children than they do these days. Kids were considered assets who would help the family and take care of Mom and Dad in their old age, and modern birth control was not available. People are living longer now, too. In 1930, the average lifespan was 58 for men and 62 for women. In 2020, those numbers had zoomed up to 75.1 and 80.5, respectively. Retirement age has not changed much at all over those 90 years; the expected norm is still at age 65.

Immigrants and Social Security

Contrary to popular belief, undocumented immigrants cannot claim benefits under the Social Security program, even though they and their employers often pay taxes into the system. Documented immigrants must qualify for the program, either by having 40 US work credits just like any American citizen or by coming from a country that has a totalization agreement with the US. More than 25 nations have such agreements, allowing workers to combine credits earned in their home country with credits earned in the US. 
Does it have to be invested in Treasuries, you may wonder? Every other pension fund in America (and internationally, by the way) has diverse holdings. More than 6,000 state and local public pension funds manage $4.5 trillion, according to Boston College’s Center for Retirement Research. That makes them one-and-a-half times the size of the whole Social Security trust fund, and more than 80% of their money is working in assets other than bonds: stocks, private equity, real estate, commodities and more. 

Oh, and what was their average return last year? Take a guess … 29%. But 2021 was an exceptional year in the market, you might argue. How have they done on a longer basis? Over three decades, the average return of these funds was 8.8%, according to Boston College’s Center for Retirement Research. Social Security has not earned 8.8% once in those 30 years. The average return for Social Security funds from 2000 to 2021 was a measly 3.2%. Anyone who understands compounding will be horrified by those numbers. 

Possible Solutions

The gap between what Social Security is paying out and what it needs to remain solvent widened another $3 trillion last year alone. What can be done? 

  • Obviously, lawmakers could change the rules and invest Social Security funds in a broader assortment of assets that typically produce higher yields. 
  • Taxes for Social Security could go up on all workers and employers.
  • The tax cap for Social Security, set at $147,000 for 2022, could be pushed upward. This is the annual dollar amount of wages subject to taxation for FICA.

Only the first option is pain-free for workers, but it may be the least likely to become reality. Politicians enjoy having your money in the budget to spend. It is doubtful that anything at all will happen until we are faced with a budget cliff, because no one wants to be known as the person who voted for higher taxes. (Interestingly, when the Reagan administration wanted to tax Social Security earnings for the first time in 1983, he had bipartisan support and the amendment passed). 

While the solution may not be clear, it is a pressing matter for those of us who depend, or who will soon depend, on Social Security checks for part of our retirement income. It is worth discussing with your representatives to hear what they propose. Older Americans have a huge stake in the outcome.


Blog posting provided by Society of Certified Senior Advisors