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What You Should Expect From Social Security

Social SecurityYou've probably heard the news: Social Security recipients aren't getting a bump up in their benefits next year. The Social Security Administration recently announced that because inflation has been flat, there will be no cost of living adjustment for seniors.

Whether or not you think that's a good thing depends a lot on your age. Seniors are upset, but younger workers have reason to celebrate the news: Fiscally conservative choices now could mean a stronger system later.

There are plenty of reasons for 20 and 30-somethings to worry about the future of their Social Security payments. The Social Security trust fund will start taking in less than it pays out around 2016, and by 2037, as today's 30-somethings start thinking about retiring, it's scheduled to run out. At that point, if nothing changes, the benefits will shrink to about three-quarters of what they are now because only money that is then being paid into the system will be paid out.

Workers have clearly gotten the message that they're largely on their own: Just-released numbers from Charles Schwab reveal that almost half of the general population say they do not plan on counting on Social Security as a source of income in retirement.

The uncertainty over future benefits has led to a debate over whether the current budget and entitlement structure is fair to young people, who may never see all of the money that they pay into the system. (Social Security benefits are based on a person's average earnings over his lifetime and depend on the age of retirement; the current maximum benefit received is $2,346 per month for those who retire at age sixty-six.)

"They should be upset, and concerned that Social Security is structured in a way to give them less than they might otherwise receive. They'll certainly get less than their parents and grandparents, and they're stuck in a position where they are either going to pay higher taxes or get lower benefits, or, what's worse, both," says David John, senior fellow at the Heritage Foundation.

As Andrew Biggs of the American Enterprise Institute puts it, "There's no way Social Security is as good a deal for a 20-year-old as it is for a retiree today."

The AARP, which represents retired Americans, has a different perspective. It is quick to point out that there is such great political support for Social Security that it is not in danger of slipping away. The organization released a statement opposing the cost-of-living freeze after the Social Security Administration made its announcement late last week.

While the AARP is right to point out that Social Security isn't going anywhere, it's possible that it will undergo major changes in the coming decades. Here are some of the possible shifts:

Higher taxes, especially for high-earners. Social Security is funded through payroll taxes, which are currently capped at $106,800. That means workers don't pay Social Security taxes on income above that amount. Congress could raise that limit.

A higher retirement age. Changing the retirement age to 68 from 65, instead of the 67 it's currently scheduled to reach, could mean a reduction in benefits for younger workers since they'd have to wait longer to collect their payments. If premiums or Medicare-related taxes are increased or benefits are reduced, that would also have a major negative impact on young workers' retirement finances.

A new government-backed investment plan. Some academics, including Alicia Munnell, director of Boston College's Center for Retirement Research, have proposed an altogether different method of risk management — one where the government bears the brunt of the risk. She imagines a new kind of guaranteed account, where the government would guarantee that beneficiaries receive a certain rate of return on their investments.

If the market plunged before they retired, then Uncle Sam would make up the difference. If a relatively modest guaranteed rate of return were chosen, such as 6 percent, then she says the government would rarely have to step in, so the cost would be minimal. Another option is to guarantee just a 2 or 3 percent return but to allow investors to keep any higher return provided by the market. If the government found itself needing to pony up during bad periods like the current one, then, Munnell says, "it can take on more debt and spread the losses over several generations," instead of forcing the soon-to-be retirees to absorb most of the pain.

Regardless of what changes, one thing is certain: Young workers need to save more on their own, because government programs are unlikely to comfortably fund a relaxing couple decades by the beach.

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