What’s Wrong With Social Security?

The health of Social Security is a much-discussed topic in the media and on the political stage. Since Social Security is so important to retirement planning, workers want to know if they can count on Social Security benefits. But these days, that can’t be certain. What is wrong with Social Security? Before getting into that, let’s start with the basics.

Social Security: The Basics

Social Security was born as a result of the Great Depression. The Social Security Act was signed into law by President Franklin D. Roosevelt in 1935. The program created a financial safety net against poverty for retirees, dependent spouses, and children of deceased workers.

Social Security has been described as a “pay-as-you-go” system because it is funded primarily by payroll taxes. Throughout their working years, employees and their employers, as well as self-employed individuals, each contribute a fixed percentage of earnings toward the program. These contributions are then used to pay benefits to current retirees and beneficiaries.

Every employee and their employer each pay 6.2% of the employee’s income to Social Security and 1.45% for Medicare. Self-employeds pay 12.4% and 2.9%, respectively. Although there is no limit on income subject to Medicare tax, Social Security tax is capped once earnings reach $168,600 (for 2024). This means that high earners will pay only the Medicare tax on amounts earned in excess of the cap.

Social Security Benefits

Individuals are entitled to Social Security benefits as long as they have paid into the system for at least 40 quarters and have reached age 62. Social Security benefits are based on the earner’s “average indexed monthly earnings,” which is a calculation that considers the highest 35 years of earnings adjusted for inflation. The next step is the application of a progressive benefit formula that results in lower earners receiving a higher percentage of their average earnings compared with high earners.

The age at which one begins receiving benefits affects the amount to be received. Beginning benefits at age 62 comes at a cost—a permanent reduction in the monthly benefit amount. The “full retirement age”—the age at which individuals are eligible for their full benefit—depends on their birth year. The full retirement age is 66 if you were born from 1943 to 1954. The full retirement age increases gradually if you were born from 1955 to 1960 until it reaches 67. For anyone born 1960 or later, full retirement benefits are payable at age 67. Delaying retirement beyond the retirement age results in an increase in the monthly benefit of 8% per year up to age 70 (the maximum benefit amount).

There are lots of fine points to optimizing Social Security benefits, considering factors such as health, spousal benefits, age of work stoppage, other investments and savings, and personal preferences. (This is where getting guidance from a qualified professional can help!)

Is Social Security a Tax or an Investment?

Although Social Security is often described as an investment, because it provides a guaranteed income stream in retirement, it’s more akin to a tax. The following reasons support why Social Security functions more like a tax than a traditional investment:

• No Control Over Contributions: Unlike an investment where the individual chooses the amount to contribute, Social Security contributions are mandatory.
• No Control Over Returns: Individuals have no control over the benefit formula or how their contributions are used. In fact, amounts collected from each individual are not invested and are not used to pay future benefits to them. Amounts collected today are used to pay benefits to current retirees and beneficiaries. Future generations will be expected to pay for current workers’ eventual benefits.
• Limited Returns on Investment: Social Security benefits are not affected by investment returns but instead are calculated from a benefits formula based on payroll taxes collected.

Once defined as a tax, the parameters for judging and modifying the system become clearer.

The Regressive Nature of Social Security

The current Social Security structure is a regressive tax system. Not only is the tax rate the same for all workers, the cap on wages subject to Social Security tax essentially punishes lower earners. In other words, high earners pay a smaller percentage of their overall income toward Social Security than low- and middle-income earners whose entire earnings fall below the cap.

Is Social Security in Trouble?

Social Security is increasingly in the news for concerns about its sustainability and financial impact. Perhaps the biggest uncertainty surrounding Social Security is its long-term financial viability. If funds run dry, future generations could be left without the safety net they’ve come to expect and rely on. This concern is compounded by the demographic shift as the US population ages and the ratio of workers to retirees decreases—meaning the younger workers might not be able to adequately fund the retirements of older workers.

The regressive nature of Social Security is also problematic. The current system places a heavy burden on those who are already struggling to make ends meet.

Building a Sustainable and Fair Social Security

Social Security is a vital program but might not be sustainable in its current structure. Attempting to solve the problem by increasing the tax rates and raising the retirement age will only further burden lower earners, without ensuring long-term viability. To increase the fairness of the tax and ensure the long-term sustainability of Social Security, I propose lowering the tax rate and removing the cap:

• A slightly lower tax rate could ease the burden for low to medium earners who pay a significant percentage of their earning in taxes.
• Eliminating the cap on earnings subject to Social Security tax would create a more equitable system while providing increased funding to sustain Social Security for the future.

Alternative Approaches to Social Security

Avoiding the funding aspect of Social Security, some observers focus on how the funds are invested—advocating for individuals to manage their own Social Security funds. Treating Social Security tax payments as private retirement accounts is not how the system is structured; taxes are paid to fund current retirees. Even so, proponents of this approach are overlooking other several significant dangers:

• Market Volatility: Social Security provides a safety net for individuals by pooling funds and defining distribution rights. Allowing individuals to manage their own funds exposes them to market risks. A market downturn could severely affect retirement savings, leaving individuals vulnerable.
• Lack of Expertise: Most people are not financial experts and might not effectively manage their retirement savings. Without a willingness to pay for qualified guidance, they could make poor decisions or fall victim to scams—jeopardizing their financial security in retirement.
• Inequality: Privatizing Social Security could further widen the gap in existing wealth disparities. Those with higher incomes or access to professional advice would likely fare better than lower-income individuals.
• Unpredictable Returns: Social Security provides a guaranteed source of income in retirement, regardless of market conditions. Privatizing Social Security would subject retirement savings to the ups and downs of the market, potentially resulting in unpredictable and inadequate returns for retirees.
• Administrative Costs: Managing individual accounts would incur administrative costs, resulting in reduced returns. This could disproportionately affect those with smaller savings balances.

While the idea of individuals managing their own Social Security funds may have some surface appeal, it carries significant risks and drawbacks.

Battered but Not Broken

Social Security is not broken, but it has issues. In order to continue to provide a retirement safety net for workers, Social Security needs shoring up. As a tax system, it needs to be equitable, while providing for the taxpayers. To ensure financial viability and fairness, the cap should be removed. To ease the burden on low to medium earners, the basic rate should be reduced. In any event, any proposed reforms to Social Security should prioritize ensuring the financial security of all workers, particularly the most vulnerable, in their retirement years.