Is Social Security really just a giant Ponzi scheme?

I finally got around to reading the 2022 Social Security Trustee Report which came out last month.

It wasn’t fun.

Even numbers nerds like me find these kinds of documents a necessary evil to stay up on the reality of the future of retirement benefits ala the US government. Reading them requires a constant caffeine drip because they are about as interesting as a Quantum physics textbook to anyone other than Quantum physics devotees.  The 2022 report is the 82nd report that has been prepared with the help of the Social Security Administration’s actuaries (the government’s numbers nerds), since the beginning of the program. The Trustees Report estimates the cash inflow and outflow of the various funds, considering projections of both demographic and economic factors.

As people watch their 401(k) balances fall off a cliff…again…people worry. Not just about whether they’ll have enough money to retire when they want to, but if they’ll be able to retire at all if Social Security goes bust. As a result, I get a constant stream of questions about the predicted insolvency of Social Security.  

Here’s what we know about retirement benefits, courtesy of the 2022 Social Security Trustee Report:

“The Old-Age and Survivors Insurance (OASI) Trust Fund, which pays retirement and survivors benefits, will be able to pay scheduled benefits on a timely basis until 2034, one year later than reported last year. At that time, the fund’s reserves will become depleted and continuing tax income will be sufficient to pay 77 percent of scheduled benefits.”

And regarding Medicare Part A, the news is even worse:

“The Hospital Insurance (HI) Trust Fund, or Medicare Part A, which helps pay for services such as inpatient hospital care, will be able to pay scheduled benefits until 2028, two years later than reported last year. At that time, the fund’s reserves will become depleted and continuing total program income will be sufficient to pay 90 percent of total scheduled benefits.”

That’s not exactly distant future.

And while they don’t expect to go belly up, I know a whole lot of people who will look at a nearly ¼ reduction in their Social Security check as right next to a death knell because they rely so heavily on that money every month to pay their bills.

After paying into the system for 30 to 40 years, people naturally wonder what the heck went wrong with a system that’s been paying out for 80 plus years. And if you don’t all the behind-the-scenes shenanigans that has gone on regarding how the Social Security “trust fund” is accounted for on the government’s balance sheets, it kinda looks like a big Ponzi scheme that is finally falling apart at the seams because there’s not enough new money coming in to pay out what was promised. In fact, when you understand all the details of how the government set this up and how they continue to mess with it, it looks even more like a Ponzi scheme!

In order to really understand how we got in this predicament you really have to understand the history of Social Security.

I talk about this problem in detail in my book The Millennial Money Tree but I’ll summarize it for you here. The Social Security Act, signed into law by President Franklin D. Roosevelt in 1935, created Social Security, which was deemed a “federal safety net for elderly, unemployed and disadvantaged Americans”. The main stipulation of the original Social Security Act was to pay financial benefits to retirees over age 65 based on lifetime payroll tax contributions.

Widows and old folks. How magnanimous of our elected officials. Sounds good, right?

Until you realize that the average American worker in 1935 died before they reached the age of 60. It wasn’t until 1950 that the average life expectancy reached 65. Meaning, that you had to outlive the average Joe before you ever saw a dime.

Contrast that to today when the average life expectancy is 76 and more than 1/3 will likely live well past 90. That means they could be entitled to Social Security benefits for almost 1/3 of their lifespan. See the difference? Negative six years vs a likely minimum of 11 years (all things being equal starting at 65 rather than age 62 like you can nowadays) and probably much longer than that.

And here’s the bigger problem.

Social Security is paid for by the FICA payroll tax and taxes on the benefits themselves. FICA stands for the Federal Insurance Contributions Act and that money is deducted from each and every paycheck. Naturally, most people think they are “entitled” to receive Social Security benefits since they’ve paid into the OASDI program for so long. But the mistake is in the second part of that last sentence. There is no Old-Age, Survivors and Disability “Insurance program” in the traditional (or legal) sense. Our government perpetuates the belief that you are entitled to Social Security by referring to money taken out of your paycheck as “contributions” but Social Security is a tax like any other tax. And, believe it or not, legally, you’re not ‘entitled’ to a dime if they shut it down.

Here’s the bigger problem: The number of people paying into the system is getting smaller and smaller and the number of people getting paid out from the system is increasing dramatically year over year.

Baby boomers are turning 65 at a rate of about 10,000 a day until 2029 and the vast majority of them will be dependent on Social Security for a good part of their income for rest of their lives – which may well be 20 to 30+ years. In the US, there are about 57 million people in retirement today, by 2034 there will be in excess of 76 million. And, so you have an idea of the complexity of this problem, the number of workers paying into the program was 16.5 per retiree in 1950; by 1960 that number was only 5.1. It has since declined to 2.8 in 2021 according to the ’22 Trustees’ report.

And as a result, here’s where the balance sheet stands:  

“The asset reserves of the combined trust funds were about $2.85 trillion at the end of 2021. The combined trust fund reserves decline on a present value basis after 2021, but remain positive through 2034. However, after 2034 this cumulative amount declines and becomes negative in 2035, which means that the combined OASI and DI Trust Funds have a net unfunded obligation through the end of each year after 2034. Through the end of 2096, the combined funds have a present value unfunded obligation of $20.4 trillion.”

Read that last part again. $20. 4 trillion dollars?? That’s only about 10% less than our entire national debt and darn near our entire current GDP.

Holy cats that’s a lot of money. Where in heaven is that going to come from?

Is it any wonder why people call it a big Ponzi scheme? The whole premise being that as the population grew, there would be more people paying into the program to support the outflow of benefit $$ and fewer people taking more out than paid in because some percentage would die before they ever got a dime.

Oops.

So, what’s to be done?

Well, first you need to understand that this isn’t the first time that Social Security has been in dire straits. Way back when, Social Security benefits were tax-free, but that all ended in 1983 with the signing of the Social Security amendments to keep the program from going broke back then. The Bandaid brand solution was that since your employer paid half of the FICA tax for you, you should be willing to pay taxes on the half you didn’t pay for initially.

Come on, it’s patriotic to pay taxes, right?

So then, part of Social Security benefits became taxable for people who earned above a certain amount beginning in 1984. If the sum of your adjusted gross income, nontaxable interest and half of your Social Security benefit exceeded that amount, up to 50% of your Social Security benefit was subject to income tax. But of course, down the road more money was needed so now, up to 85% of benefits are taxed for those with incomes above certain levels. Higher-income taxpayers also pay a Medicare premium surtax, the higher the income, the higher the surtax.

Today, the first tax bracket typically allows the government to tax 50% of a retiree’s Social Security income, and the second bracket moves up to the 85% level. Which means that for someone with a $1,000-per-month Social Security income, that either $500 or $850 could be subject to taxation along with any of the retiree’s other income sources.

Interestingly, when I wrote my book, in 2020, the expectation of payouts after 2034 was 89% in the Trustees’ report from 2019, but the scuttlebutt from insiders was already at 77%. Now, just two years later they’re admitting that number is accurate. What’s it going to be 12 years from now?

So yeah…while you can’t really call it a Ponzi scheme because the government doesn’t profit from it and they keep making changes to fix it (more like kicking the can down the road until they can’t), from my point of view, if it looks like a duck, walks like a duck and sounds like a duck? It’s a least some kind of waterfowl.

You’re definitely going to see some more changes come within the next decade. It may be a reduction in benefits payable to people in the future, or more taxation somewhere to fund the currently obligations – most likely both. And while Congress always talks as if such changes will only affect the wealthy, far too many people who consider themselves middle class will pay a bigger than fair share of these future penalties. That’s a given.

You’ll be wise to prepare in advance to be one of them.