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How Does Social Security Work, And Why Does It Need Reform?

Image courtesy of DonkeyHotey via Flickr

While a feeling of entitlement may cause you demand your food be sent back at a restaurant, in terms of the legal system, an “entitlement” by definition is guarantee of access to something by law.

Social Security is the most commonly usede entitlement program next to Medicare and Medicaid, and has been controversial due to its relationship with taxes and America’s $17 trillion national deficit.

Here’s how it works, and why certain aspects could lead to trouble in the future without reform.

Who is Social Security for?

Almost everyone! Social Security works when working adults are taxed on their paychecks, part of which goes to benefits for those in old-age, survivors, or disabled persons who lack in income for various reasons.

According to the Official Social Security Website, persons over age 62, as well as persons blind or disabled, are eligible for Social Security benefits based on their past earning records.

How does it work?

6.2% of wages is taken from each of an individual’s paycheck with an additional 6.2% matched by employers. Any excess is put into a trust fund so that on years when the payroll is less than beneficiaries’ needs, the difference can be made up.

This “trust fund,” so to speak, is deposited in the U.S. Treasury, which uses the money to buy bonds, leaving IOU’s to Social Security. As Social Security has run surplus for decades, and is predicted to continue this surplus, this system has worked thus far.

The amount of benefits depends on the beneficiaries “work credits” and when they choose to start receiving. Which is to say, this is not at all a government handout: if recipients also paid taxes as workers, they will receive a proportionate amount when they need it.

Married or once-married persons that don’t work outside the home are typically entitled to half of their spouse’s Social Security benefit, and those that haven’t worked may be eligible for SSI (Supplemental Security Income) if disabled or elderly.

The issues

As we stressed before in our writing on retirement, Social Security does not cover living expenses. Rather, it covers on average about 40% of a person’s income pre-retirement, which is why retirement plans are so important.

This, in light of what many have called a dangerous retirement crisis, has fueled an executive order from Obama creating a nest retirement bond called MyRA.

Retirement crises aside, however, there could be greater issues down the line, as Social Security benefits are projected to run short in 20 years. According to the New York Times, it’s predicted to remain solvent only until 2033, after which only 75% of beneficiaries’ needs could be met, short of reform.

The U.S. Social Security Administration (SSA) confirms that this increase in costs will lower benefit coverage, due to population aging, specifically with birth rates having dropped from three to two children. After Treasury assets are redeemed, they will be replaced with public debt unless benefits are lowered.

Some estimate that in 50 years, entitlements including Social Security will take up nearly all of the U.S. budget.

Reform possibilities

It’s clear that unless some changes are made relatively soon, the country could face some serious issues. Reform options include raising taxes, reducing benefits, or a combination of the two. But is there a better way?

The New York Times offers that since earnings taxes of 6.2% have not been raised since 1990, a one percentage point increase phased over 20 years could close half of the funding gap. Trimming benefits for upper-income recipients could close 10%, and raising the level of wages subject to taxing to $200,000 could close one third of it.

The trouble is, obviously, finding agreement on the matter.

Jennifer Markert