Social Security Cuts 2033: Strategies to Safeguard Your Retirement

The Social Security trust fund will be depleted. This is not a matter of if; it’s simply a matter of when. This video, we’re going to provide some context around the Social Security reserve fund, how it generates income, the benefits it pays out, but most importantly, what does this mean for you in your retirement, and are you subject to potential cuts to your Social Security income?

For the entirety of this video, we’re solely going to focus on what’s known as OASI, Old-Age and Survivors Income, otherwise known as Social Security benefits that you receive in retirement. We are not going to talk about the disability income component. That would be OASDI. Oftentimes, those two are joined together, but they are two separate trust funds and not the same thing. Also, we’re not going to discuss Medicare at all in this video.

Understanding Social Security Reserves

I want to start with this chart behind me because it clearly shows the trajectory of the reserve fund, which is designed to pay you your Social Security benefits. Currently, there is $2.7 trillion in the Social Security reserve fund. What we see on this chart here is the historical and the projected Social Security trust fund. Here we are with this black line. This was the 2023 report. It’s data as of the end of 2022.

We can clearly see, right around the time the Baby Boomers started retiring at a clip of about $10,000 per day, the reserve fund for Social Security has taken this precipitous drop, and it is projected to exhaust in 2033. Now, the green line here is the SSDI, or Disability Income Fund. The red line is the Hospital Insurance Fund. We’re just simply focusing on the reserves to pay your Social Security benefits. This is why, at the beginning of this video, I said it’s not a matter of if we run out of money, it’s just simply a matter of when.

Now, of course, adjustments can be made, and we’re going to get into some of those and how they could potentially impact your retirement. The goal would obviously be to extend this out so it exhausts later. Ideally, it would flatline at some point. We can clearly see, in its current state, it’s not a matter of if it runs out, it’s just a matter of when. Let’s start by looking at a summary of some of the findings from the report. We have about a $2.75 trillion balance in the reserve trust fund right now.

We ran about a $40 billion deficit in 2022, which simply means that all of the money that came in was not enough to pay all the benefits that went out. We had to pull about $40 billion from the reserve assets. The trust fund is expected to exhaust in 2033, which is one year sooner than the previous year’s report. At that point, only about 77% of payments will be able to be made, and that’s because that is the projection of income that will be coming in and the payments that are estimated to go out because there will be no more reserve fund to fill that deficit.

Challenges in Social Security Financing

It’s important to understand that 89% right now of the program benefits are financed through the payroll tax. It’s very important to understand the true challenge that we face. If we just ran a $40 billion annual deficit, there really isn’t any way that the reserve fund should be exhausted by 2033. Think about it. 10 years times $40 billion is $400 billion. There should be plenty of money left in this reserve fund.

What this is telling us is there is going to be an explosion in the annual deficit incurred by Social Security, which means the payment it is going to have to pay out versus the income it’s going to take in, that imbalance is going to explode over the next nine years, and that is what’s going to lead to the exhaustion of the reserves in the trust fund by 2033. As we go through this video, we’re going to dig a little deeper into why that is and what can possibly be done.

Behind me is a chart that actually comes from the 2023 Trustee Summary Report. If you do want to go through this yourself, I recommend Googling 2023 Social Security Trustees Summary Report. It’s going to be much easier to go through than the full report itself. Reserves at the end of 2021, $2.75 trillion. The chart is in billions. $2,000 billions is $2 trillion. $2.75 trillion. We had income of $1.05 trillion. The cost was $1.09, almost $1.1 trillion. Net change in reserves, $40 billion. Then reserves at the end of 2022, $2.7 billion.

First, on the previous slide, when I went through the reserves as of the end of 2022, I actually wrote down $2.75, but that was as of the end of 2021. The end of 2022, we’re actually at about $2.7 trillion. I want to make that correction real quick. We can clearly see where the deficit comes from. We simply are taking in less income than we’re paying out. Now I want to dive into the two components that make up Social Security: the revenue side and the cost side.

Understanding Payroll Taxes and Caps

The revenue side, as I said previously, about 89% comes from payroll taxes. Payroll taxes are 10.6%. That’s the rates, the portion of FICA. Then you also have a cap on wages. Really two components here. You have the rate that is being charged and then the cap, which represents the maximum amount of W-2 wages or let’s just call it wages that can be taxed at the given rate. Now, some of you may recognize that this number is different from what you may be accustomed to, especially if you’re a business owner.

Your total FICA taxes is about 15.3%, half paid by employee, half paid by employer. That 15.3% is broken down for different let’s call it itemizations. The part that directly goes to Social Security benefit payments, excluding disability insurance, and also excluding Medicare insurance is 10.6%. 50% by the employee, 50% by the employer. If you want to see that in the trustee’s report, we have it right here. 5.3 and 5.3. 10.6 for Old-Age and Survivors Income. Disability income represents 0.9, 0.9. For a total of 12.4, but only 10.6 goes to Social Security.

If you want to look at hospital insurance, since we’re here, 1.45, 1.45, employees, employers for a total of 2.9. The other two components of the revenue equation are income taxes on Social Security benefits and also interest on the reserves in the trust fund. If you receive Social Security benefit payments, you can be taxed up to 85% of those benefits. The interest earned on the reserves is the least dependable part of this equation because as the balance in the reserve fund depletes over the coming nine years, there will be less and less money to earn interest on.

Exploring Revenue and Cost Levers

It’s important to understand that we only have these three levers to pull to change the amount of revenue that’s generated into the program when we start to discuss potential fixes later on in this video. Now let’s look at the mechanisms or levers that we have on the cost side of the equation. The total recipients, that’s the first one, that number will either go up or it will go down. I guess it’s important to understand that there are 57.2 million people currently receiving Social Security benefits, either because they were the primary worker or a dependent of the primary worker. Does not include Social Security disability or supplemental Social Security income.

We have the payments, so the government can increase or reduce the amount of payments that they actually pay out. That’s a lever that could be pulled. Then we have the cost-of-living adjustments, the formula for inflation. Here’s the downside of some of these levers. The total recipients is likely to increase because 10,000 people every single day reach the age of eligibility for turning on Social Security. Unless 10,000 people or more pass away every single day, the total recipients is going to increase.

The total payments, that is going to increase because when you take the total recipients and you increase that, now you have more payments going out. The aggregate of total payments going out, the expense out of the equation, is also going to increase. The cost-of-living adjustments, this is a natural component that will increase over time because it takes all of the existing benefits, all of the total recipients, all the current payments that you’re making, plus future payments, and then the sense that once they’re received, they will receive a cost-of-living adjustment.

It simply compounds the payment that you paid last year by a rate of inflation. A quick chart from the trustee summary report to simply show how significant the payroll tax component is of the income side of the equation or the revenue side of the equation. $945 billion came from payroll taxes. This is program income in 2022. The actual taxes on your Social Security benefits, this does include taxes on disability benefits, $47.1 billion, and then interest earnings, $63.5 billion.

This $63.5 billion, it’s going to decline pretty significantly to zero as that trust fund goes to zero. Taxes on benefits, we would expect that to increase because more and more people are receiving Social Security, but probably not by a significant enough margin to really impact the overall equation. Payroll taxes, so this is the big lever that the Social Security Administration, or I should say the IRS or Treasury, can really look at impacting to make some significant changes to the revenue side of the equation.

Just a quick snapshot here of when the trust funds are expected to be depleted. We have Old-Age and Survivors Income expected to be depleted by 2033. When you include disability income, 2034. Hospital insurance, for what it’s worth, Medicare Part A, 2031. Okay. I want to dive a bit more into some of the levers that the government can pull in order to increase the revenue side and also the cost side. Here we have again the revenue side. Current rate 10.6, the cap 168,600.

Means Testing and Potential Impact

These are the two obvious ones because again, 89% of the income comes from the payroll tax, and the rate could go up. The question is, what type of impact does this have on jobs? What type of impact does it have on GDP? What type of impact, overall, from an economic standpoint, does taking more money out of workers’ paychecks have on the overall system? One of the common themes that we are going to discuss here, because I think this is the most likely outcome, is going to be some type of means testing. Meaning if you have a certain level of income or exceed that threshold, there is a tiered system introduced as far as increases to the rate that you pay on your payroll taxes, and that would go right along with the overall cap.

Maybe it’s 10.6% on the first 168,600 of income, but then if you have income above this to 300,000, it is a 12.4%. From 300,000 to 600,000, it’s 15.2. Something along those lines. It is important to point out here that the Social Security cap rate does increase every single year, according to a formula from the government. This is a pretty big lever that they could potentially pull. The next one is the tax on existing Social Security and disability benefits.

Increased tax on benefits. This is probably the least palatable, but again, from a means testing perspective, if you have over X amount of income, your Social Security could possibly be taxed at higher rates. These are all to increase the revenue side of the equation. You could increase the number of payees. How do you do this? You do this through immigration. If we’re able to figure out the legal immigration system, we’ve had millions and millions of people enter this country, theoretically.

If they were allowed to be here legally, the government could be looking at this as a form of increasing the number of payees to pay into the system. Increase the investment income, that’s simply not going to happen because in order to increase the investment income, one of two things would have to happen. You’d have to increase the total reserve balance, which as we know, that is going straight down, or you’d have to change the investment philosophy to take more risk with those investments to generate higher expected returns.

That’s not going to happen because we have a less than 10 year horizon here. It would not make sense to increase the risk. As a matter of fact, not only is it going to decrease most likely because the balance is depleting, but interest rates are expected to decline. That would lead to a further reduction in interest revenue. Unfortunately, I don’t think there are many things that can be done on the revenue side of the equation to significantly increase the longevity of the trust assets.

Theoretically, if we just doubled this payroll tax rate from 10.6 to let’s say 20, revenue could increase theoretically from the $1 trillion essentially that comes from it now, 945, I believe, to almost $2 trillion of revenue. I know the people who work here at Oak Harvest Financial Group, if they saw a line item on their pay stub where twice the amount of money for Social Security taxes would take out, they would revolt. There would be some significant questions in the HR department here.

Then if we looked at just means testing it to “wealthy people only,” in air quotes here, I don’t know what the government may define as wealthy, but there simply aren’t enough people making $300,000, $500,000, $1 million a year to where we could increase that and move the needle in a significant manner. On the revenue side, some things can be done. We can increase the payroll cap, could increase the rate, we can means test it all the way up, create these different thresholds, but I’m just not certain it’s going to move the needle in any significant margin to really solve the problem.

Now I want to look at some of the levers on the cost side because I do believe that these are the most likely levers to be pulled. Reduce recipients. The only way to reduce recipients is to reduce new recipients because we already have 10,000 a day that are joining the payrolls. We’re living longer lives, and yes, we are living longer lives still, even though some of the mortality statistics don’t show that because when you look at the ones that matter, those that reach the age of, let’s say, 65, if you isolate those and remove people who are younger from those statistics, we are living longer lives still.

You can reduce the number of new recipients. How do we do this? We delay the full retirement age. For people my age, for people younger, instead of retiring at 67 or getting benefits at 67, you push that out, 68, 69, 70, 71, 72. We could reduce benefits. This is a possibility. I believe it is a likelihood for people who have certain levels of income over these thresholds that we talked about earlier for means testing because keep in mind that the current plan is come 2033, there will only be enough money to pay 77% of all benefits.

Under the current plan, that is what is going to happen. There will be a reduction in Social Security payments for everyone. Now, the goal is going to be, how do we fix that, how do we change that in reducing benefits for only people who earn over a certain threshold, is probably going to be part of the solutions that are put forth. You can reduce the cost-of-living adjustment. This would involve changing the formula to some extent. Again, it would have an impact not nearly as huge as reducing the number of recipients through delaying the ability to turn on Social Security until later in life for younger people, and then also reducing benefits through some type of means testing.

Real-world Examples of Means Testing

People who make $50,000 or $20,000, if you’re in poverty, you would not be impacted by anything like this. The question then becomes, what is considered wealthy? Is it $75,000 in retirement? Is it $100,000 or $200,000? We’re going to look at some actual real world examples of current means testing that other programs employ. Okay, so we have tons of means testing already in existence in this country. Most of those means tests happen on the low end of the income scale or in the poverty ranges.

If you have a certain level of income, you do not qualify for X government benefit. Think Medicaid, for example. What we’re talking about here is means testing on the higher end of the income scale. Now, there has been a lot of chatter about taxing wealth or taxing unrealized gains. In reality, I think the most likely and easiest to implement is going to be through a means testing of income because we all have to report our income to the IRS every single year. It’s a much more easy number to report and track because of the systems that we already have in place in this country.

Current means testing on the high side, not the low side of the income scale, a 3.8% net investment income tax. If you’re married filing jointly and earn over $250,000 or single $200,000, you now have to pay this 3.8% net investment income tax. IRMAA, which is a tax on your Medicare premiums, essentially, they increase the amount you pay into Medicare, starts at $103,000 if you’re a single filer and $206,000 if you’re married filing jointly.

Potential Impacts on Your Retirement

There are several tiers that increase the amount of tax you pay, but also the thresholds to achieve those higher rates of taxation. 5% capital gains. Most people think of long-term capital gains as a 15% rate, but there is also a 20% rate. Then this 3.8% surtax goes on top of that if you make over $250,000 or $200,000. To get to the 20% cap gains rate, you have to reach $583,000 of income if you’re married filing jointly or $518,000 if you’re single.

Then of course, we’re all familiar with Social Security taxation because Social Security wasn’t always taxed. These thresholds have not changed in 40 years, really since they started. 85% of your Social Security benefits is subject to income taxation, up to 85%. If you’re married filing jointly and have modified adjusted gross income above $44,000. If you’re single, it’s $32,000. As you can see, we have a really wide range of income thresholds where different means testing currently is employed.

Hopefully this was able to provide a lot of context around some of the news, some of the information that you’ll hear on TV, you’ll read on the internet, because we went through the facts, we talked about some potential solutions through the levers on the revenue side, but also the levers on the cost side, what is most likely to happen and what is unlikely to happen.

Now, how does all this impact you in your retirement? The simple answer is, if you have income of high amounts, because of either required minimum distributions, or if you’ve accumulated a lot of wealth, I think it’s fairly reasonable to assume you are at risk of cuts to your Social Security, be through some type of means testing. Is that going to be at $100,000 or $200,000 or $400,000 of income?

I don’t know. That would just be a complete guess on my part, but that’s why we went through that section here so you have a relative understanding of some other parts of the tax code with existing means testing for high income earners. If you are in the lower income parts, let’s say, and this is still a great income for retirement, but $50,000 or $80,000 or $22,000, whatever that number is, I think, in my opinion, you’re probably pretty secure from cuts to your Social Security benefits.

Ultimately, we need the people in Congress who have the power to alter some of these levers to take everything into consideration and make some adjustments sooner than later. Otherwise, according to the Social Security trustees report, you’re all in jeopardy of a 23% Social Security cut. It doesn’t have to be that way, but it is likely that something needs to get done and much sooner than later.

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