by Kristin McKenna
June 17, 2020
by Kristin McKenna
June 17, 2020
It was already projected that Social Security would begin to tap its trust fund to pay for benefits starting in 2020. That was before the coronavirus. How will a recession impact the funding of future Social Security benefits? The COVID-19 pandemic has affected every aspect of our daily life, and the Social Security trust fund is not immune.
To understand the issue, consider how the benefits are funded. The main source of funding for Social Security benefits is income from payroll taxes. During a recession or economic downturn, unemployment rises, workers are furloughed and faced with pay cuts. Even in a pre-virus world, without action, it is projected that benefits will be reduced starting in 2035.
So what does the pandemic and forced recession mean for your finances and future Social Security benefits? According to some experts, the impact might not be as significant as you’d think. The bad news? The pandemic only exacerbates the problems the program already faces in shoring up its funding.
There are two trusts under the Social Security umbrella:
As discussed, the main source of funding for the programs is the payroll tax. Employers and employees share the burden, each paying 7.65% up to wages of $137,700 in 2020.
(For those interested in the details, the OASI trust receives 10.6% of the payroll tax share, with Disability Insurance receiving 1.8%. The remaining 2.9% goes to Hospital Insurance, which pays for Medicare Part A).
The tax rate and the allocation of taxes to the trust funds have varied over time.
Most individuals are primarily concerned with the OASI program which provides Social Security benefits to retirees. It is projected that the cost of Social Security will exceed revenues starting this year, forcing the program to tap trust reserves.
Without any intervention, the trust that pays Social Security retirement benefits would be depleted in 2034. To be clear, this does not mean benefits for individuals currently receiving them would go to $0.
Right now, the payroll tax covers about 76% of the program’s total cost. So if no action is taken, based on the current cost of the program and estimates of future revenues from individuals still working, the Social Security Administration could still pay for roughly 76% of total benefits.
The Disability Insurance trust is in better shape and isn’t expected to be depleted until 2052 based on current projections.
A recession or economic downturn could impact the Social Security program in a few different ways. Primarily, a recession reduces payrolls as workers lose their jobs. In turn, this reduces the program’s income, which could force a further drawdown of trust assets.
The solvency of the Social Security program is complicated, though and depends on many other factors: workers claiming retirement early, disability claims, policy changes, longevity, growth (or decline) in the workforce, and new revenue sources like additional taxes or increasing the Social Security taxable wage base, which reduce shortfalls or generate a surplus.
As the Social Security and Medicare Boards of Trustees’ latest annual report shows, the long-range OASDI actuarial balances and trust fund reserve depletion dates accelerated in 2009 after the financial crisis.
In 2007 and 2008, the combined trust funds were expected to be depleted in 2041. In 2009, the date was pushed up four years to 2037. Since then, the projections have stayed constant or accelerated. Today, it is 2035.
The Trustees’ report shows retirement claims grew in 2009, but the increase was only temporary: in 2008, new claims for retirement benefits increased 12% and spiked to 20% in 2009 before normalizing in the years to follow.
By 2010, workers were once again retiring later in life. The Great Financial Crisis certainly supported this trend, given the impact on many workers’ retirement savings. Since 2010, the percentage of individuals claiming retirement benefits at age 62 has decreased by 12%.
According to the Urban Institute, the Disability Insurance trust was more affected than the OASI program during the financial crisis. Disability applications track closely to unemployment. Between 2008 and 2009 the number of disability applications grew by 21%.
The Center for Retirement Research at Boston College recently published a report to help illustrate how the pandemic and economic climate could impact the program’s ability to pay benefits the Social Security Administration has promised.
According to the report, if the economic impact of the COVID-19 crisis results in a -20% decline in payroll tax revenue for two years, the depletion date would move up by about two years, or by 2033.
How to fix Social Security is another matter entirely. But it is worth mentioning a few of the ideas circulating to illustrate what it may take to fund future liabilities.
According to the nonpartisan Committee for a Responsible Federal Budget, a 3.1% payroll tax increase in 2020 could keep the program fully solvent through 2094. Some other options: a 4.1% payroll tax increase in 2035, a -19% reduction of benefits in 2020, or a -25% benefit reduction in 15 years.
There is no shortage of things to worry about these days; preparing your finances for a recession is likely one of them. At this point, COVID-19 somehow breaking the Social Security system should not be of primary concern. It does, however, make it harder to keep kicking the can down the road.