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Wednesday, February 12, 2020

Why Doubling Down on Social Security Is Unfair to Gen Z and Millennials

There are two main reasons Social Security is in trouble financially: fewer workers per retiree and longer life expectancies.

Image Credit: Piqsels

Millennials and Generation Z: Do you want to fund my Social Security benefits with higher payroll taxes than I paid in the past? Especially when the likelihood is high that your benefits are not going to be as lucrative as mine?

Lesser Potential Income

I am lucky. My Social Security benefits will be funded by you and other workers, and I plan on living to 140. If you are younger, that should concern you. Right now, you and your employer are forced to contribute 12.4 percent of your income into a fund that goes into a black hole, financing some other guy’s retirement. Wouldn’t you rather put that 12.4 percent into a fund you manage?

As an eye-opening example, assume a self-employed 25-year-old makes $75,000 this year. Further assume she is required to set aside 12.4 percent of her income into a protected, tax-deferred trust, just as she must do for Social Security. But this is her account, managed by her, just like a 401k plan. If she realizes a 3 percent increase in income each year and can earn 6 percent on a conservative mix of stocks and bonds during her lifetime, her trust will accumulate to over $3,500,000 at age 70. At 8 percent growth, that number will be an astounding $6,142,000.

Contrary to popular belief, payroll taxes are not invested in a fund to secure benefits like most other pension plans.

Would you rather have accumulated these much larger sums to augment your retirement income than get the average $1,500 per month Social Security check issued today? Lesser potential income is just one of the problems with the present system.

Social Security was enacted in 1935 during the Great Depression, designed to assist retirees with a minimum monthly income guaranteed by the federal government. Since its inception, however, it has really been another source of revenue for the feds to spend on things other than Social Security payments.

Contrary to popular belief, payroll taxes are not invested in a fund to secure benefits like most other pension plans. Since the beginning, payroll taxes went first to make payments to current retirees with the balance “borrowed” by the feds for spending on things other than Social Security benefits. For most of the program’s history, the amount of payroll taxes the feds received was much higher than the Social Security payments, meaning the feds had a lot of money to spend on other things. Because of demographics, that situation has changed perilously, threatening the future of the Social Security system.

Financial Trouble for Social Security

There are two main reasons Social Security is in trouble financially: fewer workers per retiree and longer life expectancies. A pay-as-you-go system requires a lot of workers to fund it. In the early years of Social Security, the worker-to-retiree ratio was very high—in 1940 it was 159 to 1. That meant there were 159 workers funding benefits for one retiree. You can imagine the feds had a huge surplus of money from which to plunder in that scenario.

Fast forward to today, and there are fewer than three workers per retiree. This means much less revenue to fund one retiree’s benefits. As a matter of fact, the total payments due to current retirees today are greater than the payroll taxes collected. This means the feds must come up with the money to make up for the shortfall. They do that by redeeming the bonds owned by the Social Security Trust Fund. Those bonds are projected to be completely redeemed by 2034.

What can be done to prevent the implosion of Social Security? There are only a few options, all of which entail increasing taxes and/or decreasing benefits.

Once all the bonds are paid off, nothing will be left in the Social Security fund. This does not mean Social Security will end—it simply means that the only funding available from that point forward will come from existing workers. However, at current levels of payroll taxes, those workers will only be able to support 80 percent of the promised retirement payments. If the worker-to-retiree ratio continues to decrease while the life expectancy continues to rise, the benefits able to be paid will drop precipitously below 80 percent.

What can be done to prevent the implosion of Social Security? There are only a few options, all of which entail increasing taxes and/or decreasing benefits. Decreasing benefits could come in the form of an outright reduction in the promised benefits, but that might be politically impossible to do to people who have been taxed heavily in the past for promised benefits. Another way to decrease benefits would be to increase the retirement age from the current 67+ to age 70 or higher. Since a retiree would have to wait longer to receive benefits, they wouldn’t receive as much income over their lifetimes.

Doubling Down Won’t Save Social Security

However, decreasing benefits alone won’t do the trick. Many politicians want to double down on Social Security by increasing taxes. Those taxes would be imposed on the retirement and disability portions of the tax, known as the Old-Age, Survivors and Disability Insurance (OASDI) portion. Currently, those tax rates total 12.4 percent between employee and employer (for those of you self-employed, you pay the entire 12.4 percent tax on your income, none of which is deductible). Elizabeth Warren is proposing to increase OASDI taxes to 14.8 percent.

Will these potential changes save the Social Security system? Probably not. The track record of government projections is dismal.

The other way to increase taxes is to raise the Social Security threshold amount from the current $137,700. This is the amount subject to OASDI taxes; anything above this is currently exempt from the tax. This contrasts with the hospital insurance (HI) portion of payroll taxes, which funds Medicare and has no threshold amount—you pay HI taxes on your entire income at the rate of 2.9 percent between employer and employee. Bernie Sanders wants to treat the OASDI portion similar to HI and tax all incomes above $250,000 at the OASDI rates.

Will these potential changes save the Social Security system? Probably not. The projections don’t take into account increasing life expectancies and the fact that GDP growth may be less than predicted (a very real possibility in an ever-increasing tax environment). Further, the track record of government projections is dismal.

Higher Taxes

What all this means is millennials and Gen Zers will see higher taxes for Social Security across the board, perhaps many times. They will also most likely see reductions in promised benefits, especially if they accumulate a lot of money over their working lifetimes. It is not inconceivable that a future Bernie Sanders-type politician would impose means-tested limits or reductions to promised benefits when the wheels start falling off.

Are there any other possibilities? Of course. Social Security could be privatized, as it has been in Sweden and the Netherlands with great success, while protecting current retirees or older workers close to retirement. Wouldn’t you rather have your own retirement fund you manage yourself instead of the flimsy promise of government IOUs?Existing retirees with sufficient income outside of Social Security could be given incentives to forgo benefits in return for tax-exempt income, such as the ability to convert a portion of a taxable IRA to a Roth IRA. We need to think outside the box to develop a system that will protect retirees in the future.

Wouldn’t you rather have your own retirement fund you manage yourself instead of the flimsy promise of government IOUs? Increasing payroll taxes today only delays the day of reckoning. The current unfunded liabilities for Social Security are over $34 trillion. Let’s not double down on a failed experiment that will bankrupt our country in the future and leave millions destitute in retirement.


  • J. Kyle deVries is a financial planner residing in Southern California. He is the author of an Amazon #1 New Release entitled, Bern, Baby, Bern!: Why Bernie Sanders’ Policies Would Incinerate the U.S. Economy.