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Though it might be scary to think about, the grim reality is that Social Security, America's most important social program, is headed toward disaster.

Big changes are underway for Social Security

Each and every month, more than 62 million people receive a benefit check, of which close to 70% are aged beneficiaries. Of these retired workers, 62% count on the program to provide at least half of their monthly income. What's more, an analysis from the Center on Budget and Policy Priorities finds that the mere existence of Social Security payouts helps to keep more than 15 million retired workers out of poverty.

But for all the good Social Security has done, changing demographics and a few intangibles have the potential to make significant changes to the program we know today.

Image source: Getty Images.

According to the latest annual report from the Social Security Board of Trustees, more will be paid out in benefits than is collected in revenue for the first time in more than 35 years. On the surface, a $1.7 billion net cash outflow probably doesn't sound like a big deal, especially with $2.9 trillion in the Trust Fund's asset reserves. But, trust me, it gets worse.

Per the report, with the exception of 2019, Social Security's net cash outflow will accelerate rapidly beginning in 2020. In 2027, based on the intermediate-cost model, an estimated $169 billion more will be made in payouts to eligible beneficiaries than is collected in revenue. By 2034, just 16 years after this net cash outflow began, Social Security's excess cash is expected to be completely gone.

This depletion of Social Security's asset reserves is often where confusion sets in.

You see, back in 2014, Pew Research Center asked millennials whether they believed Social Security would be there to provide them a benefit when they retired, and a whopping 51% said no. There's a pervasive assumption spanning all generations (but especially younger ones) that Social Security is spiraling toward insolvency and that it won't be there to provide a guaranteed monthly payout for much longer. That would lend to the belief that Social Security has virtually no chance of being around when your grandchildren retire.

Thankfully, this assumption doesn't hold water.

Image source: Getty Images.

Will Social Security be around when your grandkids retire? You bet!

Make no mistake about it, Social Security burning through $2.9 trillion in asset reserves isn't a good thing. However, it doesn't mean the end of Social Security. In fact, Social Security's funding mechanisms are designed to allow the program to survive, in theory, forever.

Social Security has three funding sources:

  1. A 12.4% payroll tax on earned income of up to $128,400, as of 2018
  2. The interest income earned on its asset reserves
  3. The taxation of Social Security benefits

By the time 2034 rolls around, the program's excess cash will depleted, wiping out any chance of earning interest income from its excess cash. In 2017, interest income provided $85.1 billion in revenue, but this figure is liable to shrink as time passes and Social Security's asset reserves dwindle.

The heavy lifting is primarily done by Social Security's 12.4% payroll tax on wage income. Last year, $873.6 billion of the nearly $1 trillion in revenue collected was derived from the payroll tax, with $37.9 billion generated from the taxation of Social Security benefits. As long as Americans keep working, the payroll tax ensures that money will continue flowing into the program for disbursement to eligible beneficiaries.

Probably the only way Social Security wouldn't be there for your grandchildren is if Congress were to adjust how the program is funded. In other words, if lawmakers removed the payroll tax and instituted some other form of funding, such as a value-added tax on consumption, which is an idea a Republican lobbyist tossed around last year, then it becomes possible for Social Security to be insolvent. But as the program is currently set up, your grandkids are on track to receive a payout when they retire.

Image source: Getty Images.

Understanding the difference between survivability and sustainability

Ultimately, Social Security's problems aren't about survival -- they're about payout sustainability.

With the ongoing retirement of baby boomers weighing down the worker-to-beneficiary ratio, longevity steadily increasing over time, income inequality growing worse, and lawmakers doing nothing to fix Social Security, the current payout schedule simply isn't sustainable.

So, what's that mean? Essentially, Congress has three choices:

  1. It can choose to raise additional revenue to offset the expected $13.2 trillion cash shortfall between 2034 and 2092, most likely by eliminating or raising the maximum taxable earnings cap, or increasing the payroll tax on all workers.
  2. It can choose to cut expenditures, which, as an example, could be done by raising the full retirement age.
  3. It can institute some combination of revenue raising and cost-cutting.

What will lawmakers do? No one really knows. About the only given from lawmakers when it comes to Social Security is that they'll wait as long as possible to actually address the problem.

But according to the Trustees report, failure to deal with Social Security's issues has some pretty dire consequences. If Social Security's cash reserves are exhausted, an across-the-board cut in benefits of up to 21% may be necessary to maintain payouts through the year 2092.

Furthermore, the longer lawmakers wait to fix Social Security, the more painful it will be on the public's pocketbooks. In 2018, the Trustees report calls for an immediate 2.84% increase to the payroll tax (i.e., a 15.24% payroll tax, instead of 12.4%) to resolve the program's 75-year cash shortfall. But wait a few decades, and the needed "fix" could near a 4% payroll take hike.

In sum, yes, Social Security will be there for your grandchildren. However, it's unlikely to offer the same financial foundation granted to you or your parents given the program's noted issues.

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