Broker Check

On the Solvency of Social Security

| September 30, 2021

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Social Security’s shortfall grew by a record 18% in the last year. That $3 trillion increase means that it is more likely beneficiaries will face reduced benefits in the future, and the longer we wait the harder it will be to solve the problem.

The Trustees Report for the Social Security Trust Funds was released on August 31, 2021, and, within hours, all 270 pages of financial information was condensed by the media into a single sentence:

Based on the latest Social Security Trustees Report, the combined OASDI program will be insolvent by 2034, at which point there will be only enough incoming revenue to pay out 78% of scheduled payments.

Strangely enough, that synopsis was enough to satisfy the curiosity of most Americans about a system on which many of them will depend in old age. Generally, the average person believes that this sentence means that Social Security is a train on the same track, only a little bit closer. In fact, the report in a fuller light means is that the train now approaching is 40% bigger than it was two years ago, running on tracks that are less stable.

Advisors need to have a firm grasp of the system’s finances because a lot of clients will not.

Social Security’s relative importance

While most Americans pay nominal tribute to Social Security’s role in retirement planning, fewer of them fully appreciate the degree to which they may depend upon the program in old age. Based on median- retirement savings of Americans approaching retirement (about $100,000), the program provides income streams that represent the largest asset in your client’s portfolio. The present value of expected Social Security benefits is more than $350,000 for a typical American worker retiring in 2020, and $700,000 for a married couple with both spouses earning average wages of slightly more than $50,000 in 2020.

Social Security plays a larger role in a retiree’s well-being than they realize. Statistically, the relative importance of Social Security rises with age, and few retirees give full consideration to the possibility that they may be fortunate enough to live to 100.

Worries about those born in 1960 were overblown

Whether your clients were aware of it, they may have faced substantial benefit cuts that would last a lifetime – because of the year in which they were born. Initial estimates suggested the economic loss for retirees born in 1960 would exceed $70,000 over a typical retiree's lifetime.

The concern was the average wage index might fall. In fact, to the contrary, the latest forecast in the Trustees Report predicted that average wages rose 2.7% in 2020. Advisors should keep the issue on their radar because formalized figures are not available until October.

More information on the Average Wage Index is in the Appendix to this article.

The shortfall grew by a record $3 Trillion

In the latest Trustees Report, the shortfall (or the gap between what the program has promised and what it expects to collect over the next 75 years) grew by 18% from $16.8 trillion to $19.8 trillion.

That was the largest one-year increase in the shortfall in the history of the program. Another way to look back at the year past is to say that for every $1 that the program collected, it created $3 of promises that it must keep for the program to remain solvent. This closely follows the results from 2019 when the system generated $2.9 trillion in unfunded liabilities.

Over the last two years, the size of the system’s unfunded liability over that 75-year timeline has grown by more than 40%.

From an advisor's position, it is not possible to guess the future. You should help your client understand the present. This can be challenging when your client introduces preconceived ideas about Social Security into the decision-making process. Americans tend to live in a state of denial about the importance that the program has to their financial health, the cost to address those issues, and the consequence that will fall on them as individuals.

The detachment from the issue stems from the belief that they will be spared the consequences of insolvency. They believe that Congress will step-in and save the day much like the cavalry did in movies that they watched when they were young. We live in a state of denial about Social Security, romanticizing the events of the 1983 when Congress stepped-up in a bipartisan way to fix the program. But the situation from 1983 is not relevant today (see here for more detail).

More information on the shortfall is in the Appendix to this article.

No guarantees

With Social Security there are no guarantees. This is not my opinion. It is the opinion of the Supreme Court. This isn’t a problem until the client takes the past track record of the program as an indicator of the future. The client needs to understand the degree of uncertainty that comes with a forecast covering 13 years.

In terms of the Trustees Report, the exhaustion of the trust fund in 2034 is not a worst-case scenario. In fact, it is the expected outcome in a relatively robust economy. If the economy does not cooperate, the benefits cuts would come sooner, and be larger than the 22% now touted.

If the program were able to pay scheduled benefits only until 2034, about half of those people turning 74 today will be alive when benefits are reduced.

If I am skeptical about these estimates, it is because they assume that the weak economy will not cause income reductions for seniors. In fact, the Trustees estimates project that GDP will grow 2%t in 2035 whether seniors get full checks or partial checks. If seniors respond to less income with less spending, the promise of $0.78 on the dollar (from a 22% shortfall) becomes unrealistic.

We do not know when checks might be reduced. We don’t know the size of the reduction. We do not even know how the program would allocate system-wide reductions of 22% to the individual beneficiaries. But I am certain that the reductions start somewhere above $0.20 and decline from that point. This is the type of risk where hedges are very valuable.

As the Congressional Research Service says, “It is unclear what specific actions SSA would take if a trust fund were insolvent.”

The longer we wait the harder it gets

I was recently asked what advice I would give younger Americans about the program. There is only one thing on which every expert even loosely connected with the issue agrees: The longer we wait the harder it gets. The passage of time is programmatic kryptonite.

For clients of any age, the imbalances in the system have reached a scale where all the tax increases on traditional revenue sources will not stabilize its finances. Hence, the government will need to reach into new pockets of your client, and as more time passes it will have to reach deeper into them.

Brenton Smith writes on the issue of Social Security reform with work appearing in Barron's, Forbes, MarketWatch, TheHill, USAToday, and more. He can be reached at



Average Wage Index (“AWI”)

The average wage index (AWI) is the most important aspect of Social Security – and the least discussed. It determines how much retirees are paid, and the amount of tax a worker might face. It is the autopilot that runs the program and has been since the late 1970s.

The official data for the 2020 AWI will not be available until October, but the current Trustees’ Report projects that the average wage index grew about 2.7%. Essentially, we had roughly the same number of workers covered by Social Security, collecting higher wages, receiving commissions throughout the year, and comparable bonuses at the end of the year.

You should check in on the official results in a month or so because it will set the benefit level of people who might start to file for benefits in January. For the time being, your client is safe.

The retiree’s primary insurance amount is based on historic earnings indexed to “average wages” of the year in which the retiree turns 60. While you may have worked for $15,000 in 1983, the program’s benefit calculation would see something closer to $50,000 if you turned 60 in 2019.

This concept is great for those reaching retirement in economic-boom times. It is less effective for those who turn 60 during economic uncertainty like the COVID pandemic. There was considerable concern that the pandemic might decimate the benefits for people born in 1960 who turned 60 in the middle of the pandemic.

For those interested in the detail, I wrote about benefit cuts for those born in 1960 back in March of 2020; research ("How the Coronavirus Could Permanently Cut Near-Retirees’ Social Security Benefits Security Benefit") followed, and legislation was proposed to address the issue.

People have been worried that COVID would hurt payroll tax revenue collection. They were worried about Trump hurting payroll tax collection. All the worry is pushed to the side with the latest information. The initial estimate for payroll tax revenue for 2020 was nearly $60 billion greater than the system collected in 2019, but the Trustees believe that the system collected only $20 billion more than in the prior year. The initial estimate from the actuaries at the Social Security Administration estimated that the program would have to return $100 billion in over payments to the Treasury.

Many will disagree with that forecast. But I am just the messenger. The Trustees’ estimate is based on W2s filed with the Department of Treasury. The rise in productivity means that the Social Security Administration believes that we were able to accomplish the same production with fewer hours worked. I am not saying that the forecast will come to pass, only that the Trustees Report suggests that COVID was basically a round-off error for the program.

Given the role that the AWI plays in a program that provides support for so many, we should have had this question answered months ago. The AWI is dominated by wages earned above the cap on taxable wages. While those workers account for 6% of the workforce, their wages account for nearly 30% of the index. If there is a problem, we should know it by now. We shouldn’t be guessing at this point.

I have a difficult time reconciling the image that wages are growing with the need for more pandemic checks, the extension of the moratorium on evictions, and the discussion about more stimulus to save the economy. CEOs wages are flat, and a record number of Americans have fallen from the tax rolls. Look around your own neighborhood and see whether workers did better in real terms in 2020 as compared to 2019.

Given the impact that this information will have on your clients, I would recommend cycling back to look at the official number next month. The index is so important that you want to be ahead of the problem.

Unfunded liabilities (“Shortfall”)

The shortfall is the gap between what the program expects to pay and the revenue it expects to collect. These are the broken promises of Social Security, and they are predictably set to fall on people well into their 70s.

While 75 years sounds like it is far in the future, the changes in the shortfall over the past year alter the dynamics of the discussion of Social Security today. The last major proposal for Social Security was the Social Security 2100 Act. Whether it is this plan or the next, any policy initiative from the past has been obsolesced by the new information.

Since 2000, the shortfall has grown more than twice as fast as our economy. In other words, the hole in the program’s finances is growing twice as fast as our ability to fill it in.

How much concern should you have for your clients that Congress will be unable to find common ground on a solution?

Voters unconditionally trust politicians to fix this problem. They believe that no Congress would be willing to allow benefit cuts. That formula hasn’t worked well in the past, and I see no reason to believe it will work this time. Until there is some visible political commitment to the program, clients should weigh the possibility of insolvency and the impact that it would have on claiming strategies.

In terms of claiming strategies, the advice that I would give my parents is simple. The rate of growth of the problem within Social Security combined with the historical record of Congressional inaction means that benefit cuts will be part of your future.

Whether it is part of someone else’s future is up to them to decide. If a client believes that means-testing will be part of the future solution, claiming benefits early makes a lot more sense. I would stay away from the concept that delayed benefits is like earning 8% guaranteed. Nothing in Social Security is guaranteed.

If the client determines that deferring benefit claiming is the right move, he or she needs to think about how they will finance their lifestyle in the meantime. If the client relies on outside savings, talk to them about the importance of diversification of retirement income streams. If they use up their outside savings to defer benefit collection until 70, they are putting a lot of eggs into a single leaky basket.

Ideally, get them to understand the size of the problem and the likelihood that this concern will play a part of their future. The driver of the shortfall is the passage of time. Over the course of 2020, the system generated $700 billion in unfunded liabilities because we changed the valuation date by a year. The cost this year will be more next year, and even more the year after. This is the cost of doing nothing, and if $700 billion doesn’t sound like a lot, keep in mind Congress has done nothing for 40 years.

According to the Social Security Administration, Congressional inaction accounts for roughly $12 trillion in unfunded liabilities.

The projected cost rate has risen sharply over the past two years. While the base of the taxable payroll is growing, expectations of expenses are growing even faster. Higher pension expense is generally not a function of a pandemic. This is about a change in expectations.

The reported shortfall has relevance because the next 75 years serve as the yardstick for all legislation that affects the Social Security Trust Funds. In that yardstick, the shortfall is expressed in the form of the “actuarial balance.” Pick a name, solving the issue of Social Security just got 30 to 40% more difficult. (The actuarial balance has grown from 2.84 in 2019 to 3.54 in 2021.)

This does not mean that raising the payroll tax to 15.94% will solve the problem – because higher taxes on wages will lead to lower wages and fewer jobs.

If you are expecting Congress to intervene in the crisis that is currently unfolding, the last major piece of legislation to be introduced in Congress was the “Social Security 2100 Act” in 2019. The assessment of that proposal is irrelevant because of the passage of time. The only word for the taxation aspect of the proposal is “draconian.” It would have increased the payroll tax rate by 2.4% and eliminated the cap on payroll taxes. The legislation used up the traditional sources of revenue. Even with that money, the plan would come up 25% short of the goal. In other words, if Washington is going to look for revenue, it has to come from a different one of your client’s pockets.