SOCIAL SECURITY

America’s largest social welfare program.

Medicare and Medicaid combined are as large.

Social Security is a self-financing program. It is financed by payroll taxes and has always collected more funds than it spends.

Social Security has never run a deficit or contributed to the federal deficit.

A very large percentage of the population either collects Social Security or lives in a household with a recipient.

Almost half of all elderly American would live in poverty if they did not have SS.

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SOCIAL SECURITY

While Social Security is currently fiscally sound, it will have problems in the future.

The reason is that a growing percentage of our population is retiring and depending on SS.

In the not too distant future, SS will have to be amended to make it fiscally sound over the next 75 years.

This can be done and we will discuss ways to make the program viable in the future.

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SOCIAL SECURITY

How It Works and Some Ways to Make it Fiscally Sound For Another Seventy-Five Years

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OVERVIEW

How Social Security Works

• Financing Social Security• How Benefits Are Calculated and Paid

Financial Troubles

Various Ways to Fix The Problems

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WHAT IS SOCIAL SECURITY AND HOW DOES IT WORK?

Social Security began in 1935, during the height of the Great Depression. The main motivation was to provide a means of support for the elderly.

Basic structure is that workers (and employers) pay a payroll tax, and the money is used to pay benefits to the current generation of elderly.

TWO PROGRAMS

The Old Age & Survivors Insurance (OASI)

The Disability Insurance (DI)

Currently about 46 million Americans are receiving OASI and about 10 million are receiving DI.

The costs of both programs in 2011 was $716 billion—20% of all federal expenditures.

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HOW MANY PEOPLE RECEIVE

SOCIAL SECURITY?

Currently about 56 million people receive benefits from the two programs each month.

1 in 6 Americans get Social Security benefits.

Nearly 1 in 4 households receives income from Social Security.

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FINANCING SOCIAL SECURITY

Workers and their employers pay with Social Security taxes

Workers pay• 6.2% of their earning up to $113,700 for Social Security,

and• 1.45% of their earnings for Hospital Insurance under

Medicare (Part A)

Employers pay an equal amount

The total is 12.4% for Social Security and 2.9% for HI (15.3%).

The Medicare tax rate increases by 0.9 for individuals earning $200,000 or more and for couples filing jointly who earn $250,00 or more. The employer does not match this extra tax. 1

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FULL RETIREMENT AGE

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Year of Birth Full Retirement Age

1937 or earlier 65

1938 - 1942 plus 2 months per year

1942 – 1954 66

1955 - 1959 plus 2 months per year

1960 and later 67

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AVERAGE PAYMENT: JANUARY 2012 WAS $1230

How much money would you currently need in Treasury notes (five-year obligations) to yield that

amount each month?

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TREASURY NOTES CURRENTLY PAY LESS THAN 1% INTEREST

You would need at least $1.5 Million

What percentage of retired people have that much investment money?

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RETIREMENT DATE

You can retire early, but it permanently lowers your benefits.

You can also retire later, and it permanently increases your benefits.

You can continue to work after retiring, but if you make very much money, some of your Social Security benefits will be taxed.

This creates a disincentive for some of the elderly to work.

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WORKER BENEFITS:IMPACT OF EARLY OR LATE

RETIREMENTIndexed for inflation

Actuarial decrease for early retirement• Example: average-wage worker, 62 in 2011• Will get $1,380 per month at her full retirement age of

66 • or $1,007 per month at 62

Actuarial increase for later retirement• 8 percent per year

Retirement Earnings Test• In 2013, retirees lose $1 of benefits for each $2 of

earnings over $15,120.

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HOW MANY PEOPLE RELY ON SOCIAL SECURITY FOR MOST OF THEIR

INCOME?

90% of people 65 and older get Social Security

Nearly 2 in 3 (66%) get half or more of their income from Social Security

About 1 in 5 (22%) get all their income from Social Security

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HOW DO YOU BECOME ELIGIBLE FOR SOCIAL

SECURITY?Workers over 62 are eligible

• If they have worked 10 years and paid payroll taxes during that time.

Benefits are based on a workers earnings history

• Career average earnings are calculated as Average Indexed Monthly Earnings (AIME)

HOW BENEFITS ARE CALCULATED: A LITTLE

COMPLICATED

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TWO CALCULATIONS

Average Indexed Monthly Earnings (AIME)

Primary Insurance Amount (PIA)

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AVERAGE INDEXED MONTHLY EARNINGS (AIME)

Step One: Determine how much the worker earned every year through their working years

Step Two: Index those Earnings for Wage Inflation

Step Three: Pick the Highest 35 Years

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AVERAGE INDEXED MONTHLY EARNINGS (AIME), CONTINUED

Step Four: Add up those highest 35 years of earnings

Step Five: Divide by 35

Step Six: Divide by 12

Result is called Average Indexed Monthly Earnings (AIME)

AIME is then linked by formula to the basic retirement benefit

• Result is called Primary Insurance Amount (PIA)• Paid at full retirement age

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PRIMARY INSURANCE AMOUNT (PIA) 2013

PIA = 90% of first $791 dollars

Plus 32% of the amount over $791 up to $4,768

Plus 15% of anything over $4,768

$791 and $4,768 are called bend points

Adjusted each year for inflation

Always pays higher benefits relative to earnings for lower paid.

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EXAMPLE: AVERAGE AIME OF $6,000

First Bend Point: 90% of $791 = $712

Second Bend Point: 32% of $3,977 ($4,768-$791) = $1273

Third Bend Point: 15% of earnings over $4,768

($6,000-$4,768) = $1,232

15% of $1,232 = $184

Add the three: $712+$1,273+$184 = $2,119 in SS Benefits

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HOW BENEFITS ARE CALCULATED IN A FAMILY

Husband or wife gets 50% of worker’s Primary Insurance Amount (PIA)

• Together, couple gets 150%

Widow or widower gets 100% of worker’s PIA

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SOCIAL SECURITY’S FISCAL HISTORY AND FUTURE

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SOCIAL SECURITY FISCAL HEALTH

Over the 70 years of SS’s existence, it has received income of about $14 trillion and paid out $11.5 trillion in benefits.

At the beginning of 2011 there was about $2.7 trillion in the OASI trust fund and $179 billion in the DI trust fund.

In 2011 Social Security earned $125 billion on its trust funds.

The trust fund is projected to reach $3.7 trillion by 2022 or 2023.

The Social Security surplus funds are used to buy United States Treasury bonds, ranging in maturities of 5 to 15 years.

These bonds are held by the Trust Fund until maturity.

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SOCIAL SECURITY INCOME

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Interest on reserves14.3%

Income taxes on benefits

2.5%

Employer and Employee Social

Security taxes83.2%

WHY IS THERE A PROBLEM? THE LONG-RUN DECLINE

Since 2010 the surpluses added to the trust fund each year have started to shrink.

Without some changes, surpluses will continue to decline.

At some point, the trust fund will not grow and will start to shrink.

At some point the trust fund will be exhausted.

How long will this take?

That is the big question.

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HOW LONG RANGE FORECASTING ANSWERS THE QUESTION: THE

ROLE OF ACTUARIES

HOW ACTUARIES ESTIMATE THE FUTURE?

Review the past: birth rates, death rates, immigration, employment, wages, inflation, productivity, interest rates

Develop projections for the next 75 years

They develop three scenarios of how much Social Security will need to spend: Low cost; Intermediate (best estimate); High cost.

THE BAD NEWS: EXHAUSTING THE TRUST FUND

Currently actuaries project that by 2022 or 2023 benefits and expenses will exceed both payroll taxes and interest payments on the Trust Fund surplus.

At that point the program will have to start liquidating the Trust Fund

(When did Social Security’s problems begin?)

THE LONG-RANGE FORECAST(BEST ESTIMATE)

In 2033, the Trust Fund surplus is projected to be depleted.

It is projected that payroll taxes will cover only 75% of expenses and benefits from 2033 to 2085.

In other words, it will run big deficits.

If current payouts are to be maintained, benefits will have to be reduced, payroll taxes increased, retirement delayed or some other method will have to be employed.

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WHY WILL SOCIAL SECURITY COST MORE IN THE FUTURE?

The number of Americans over age 67 will grow faster than the number of workers.

Boomers are reaching age 67 People are living longer after age 67 (average about 20 years) Birth rates are projected to remain stable in the future. People 67 and older will increase from 13% to 19% of all

Americans

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HOW TO AFFORD THE BABY BOOM IN RETIREMENT?

Balancing Social Security will require somewhat more in revenue or somewhat less in benefits.

The question: Who should pay more in taxes or receive less in benefits?

HOW BIG IS THE SOCIAL SECURITY FINANCING

SHORTFALL AS A SHARE OF GDP?

The financial deficit as a share of taxable wages is 1.70 percent over the next 75 years

The same deficit as a share of the entire economy (or GDP) is 0.6 percent.

WE COULD FIX THE PROBLEM BY RAISING THE SOCIAL SECURITY TAX

The gap would be closed if the Social Security tax rate were 1.70% higher.

That is, 0.85% higher for both workers and employers, or 7.05% instead of 6.2% today.

This would fix the problem, but would not be popular.

A VARIETY OF WAYS TO FIX SOCIAL SECURITY

Raise Taxes

Cut Benefits

Raise the Social Security taxable base

Tax SS benefits

Change the benefit calculations

Delay retirement or full retirement

Increase Investment Returns

• Private investment• Either government or individual

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OPTIONS: RAISE TAXES

OPTION

Increase tax rate by 2% total

Tax all earnings

Tax 90% of earnings

Include new state & local govt. workers

Tax SS benefits like pensions

% of Deficit Eliminated

104%

93%

40%

10%

20%

OPTIONS: CUT BENEFITS

OPTION

Raise retirement age (to 68 index)

Reduce COLA by ½% each year

Cut benefits by 5% for those starting to get benefits in 2012

Increase # years in wage avg. to 40

% of Deficit Eliminated

28%

41%

32%

21%

OPTIONS: INCREASE INVESTMENT RETURNS

OPTION

Investments in equities

% of Deficit Eliminated

36% - 50%

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RECAP

Benefits are modest (dollars and replacement rates). Yet, they are most beneficiaries’ main source of income.

Benefits will replace a smaller share of earnings in the future than they do today.

Benefit cuts or revenue increases will be needed to balance Social Security.

The long-range shortfall is small as a share of the whole economy.

The question for Americans: “Who should pay in the form of lower benefits or new contributions?”

SIDE NOTES: SAFETY AND IMPORTANCE OF TRUST FUND

INVESTMENTS

Social Security critics often argue that the Treasury notes held by the Trust Fund are worthless and thus SS is bankrupt.

Total Nonsense: Treasury notes are backed by the federal government and are coveted investments. When offered, they are quickly purchased by investors all over the world. The federal government has never defaulted on its bonds and there is little chance that it ever will.

Additionally, even without earnings from the Trust Fund, current benefits would have to be reduced by a small percentage.

Assuming no change in the program, through 2033, benefits would have to be gradually reduced to about 90 percent.

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TREASURY NOTESBeyond, 2033, the payout projections would not change since it is assumed that in its current configuration the bond portfolio would be exhausted by that point.

The trust fund has a relatively small impact because SS was not designed as a retirement system in which payroll taxes were invested to create a fund for each workers’ retirement.

Instead, SS is a social compact that younger generations will devote some portion of their income to provide an income for retired Americans.

The money you pay into the system does not go to create an account for you; it goes to provide benefits for your parents and grandparents.

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