There are a plethora of misconceptions out there regarding Social Security. Some of the more common ones:
- I have a retirement account with Social Security.
- Social Security has plenty of money.
- I paid into the system, so I own something and am guaranteed payments.
Plus many, many more other mistaken ideas.
The truth is far different. Regardless of how many people have claimed otherwise, Social Security is in effect the biggest Ponzi scheme ever run. It has the false appearance of a retirement plan by design – indeed, that was only one of the lies told to get the US public to accept it. But it’s not a retirement plan in any way. If it were done by private industry, it would almost certainly be illegal.
However, until recently I didn’t know that much about the details of Social Security financing. Yes, I knew it had something called “Trust Funds” (more on why the quotes are there later in this article). But I realized I didn’t know much at all about how they worked. So I decided to see what I could find.
What follows is the result of that research. This one’s rather long – so if you’re going to read it, keep that in mind.
Overview.
Here’s a brief overview of how Social Security operates. It’s not complete, and is lacking some details. But it hits the main points. It was also compiled from various documents on the Social Security Administration web site.
1. Social Security is funded from multiple sources; those will be further identified below, but are generally identified in footnotes and/or explanatory text here and here. Those funding inputs are mingled and “laundered” through two so-called Social Security “trust funds” – which in reality are general purpose “slush funds” that receive every dollar that Social Security takes in, and from which all Social Security expenses get paid. Thus, everything Social Security receives goes into one of two such “pots”: one called “Old Age and Survivors,” and a second called “Disability”. Everything Social Security must pay out is paid from one of those two common “pots”. Anything left over at the end of the year “rolls over” and remains in the applicable “trust fund”.
2. Those Social Security slush funds “trust funds” buy “special” Treasury securities not available to the public. These “special securities” are always redeemable at face value. They also accrue interest annually. (Being government debts, the interest of course comes out of other Federal tax revenues or from borrowing by Uncle Sam.)
The Social Security slush funds “Trust Funds” buy these special securities on a daily basis. All Social Security expenses are paid by redeeming some of those “special” securities.
Since the same fund is used to receive current income and pay current expenses, this means that the “trust funds” are not investment funds. Rather, they’re merely temporary buffers – just like an interest-bearing checking account (if you can still find one of those these days). Benefits are still primarily paid from incoming tax receipts, but because these “trust funds” have a nonzero balance there’s a time lag between receipt of taxes and outlay of those same dollars due to the “trust fund’s” providing a buffer. The length of this time lag has varied over time and depends both on the fund’s balance and the average benefits dispersed monthly. Currently the Old Age and Survivors slush fund Trust Fund has a “buffer length” of somewhat over 3 years. The Disability slush fund “Trust Fund” has much less of a reserve on hand; it’s in serious trouble.
3. The Federal Government – not retirees – owns these “trust funds”. Technically, they are financial accounts belonging to the US Treasury. All benefits are paid to qualifying individuals from these “trust funds”, as are other program expenses. As noted above, it does this by redeeming those “special” Treasury securities you or I can’t buy.
4. Individuals receiving benefits actually own nothing. Since Social Security is a government benefit and not something you own, Congress can change qualification requirements, benefit amounts, or even cancel the program outright if it so desires. Don’t believe me? Well, then you might want to read the SCOTUS case Fleming v. Nestor (1960). There’s a link to that case later in the article.
5. Social Security is primarily (at present, around 88% – and dropping) funded by payroll taxes on income below a certain level. These payments are not “retirement contributions”; they are taxes that are legally mandatory. You do not have a “Social Security Account” with a calculable balance; all you have is an earning history. That earning history is used – in a rather convoluted manner, which by design grossly favors career low-income wage earners at the expense of those earning a large income – to calculate the amount of the benefit the law deems you deserve.
6. Benefits are paid, as defined by law, to those who qualify to receive them. Federal law defines who qualifies and what must be done to qualify. Qualification requires two things: meeting an age or disability threshold, and having enough “qualifying quarters” of work under Social Security for which you’ve paid your Social Security taxes. Currently, one calendar quarter of coverage credit is given for each $1,260 earned in a calendar year; earn $5,040 in a year, and you’ve got a year’s coverage. That number was lower in the past.
7. Under current Federal law, 40 quarters of coverage over your entire working lifetime – in other words, 10 years – are all that is required to be “fully covered” and receive a benefit when you retire. Benefits based solely on age can be received as early as age 62 if not for disability, and earlier for disability. Nonworking spouses receive benefits based on their spouse’s earning history. These benefits continue should their spouse predecease them.
8. Those retiring for disability generally do not require as many quarters of “credit” under Social Security, but must have varying amount of Social Security employment “credit” based on their age.
9. Not all income is subject to Social Security taxes. Only the first $118,500 of earned income (the amount changes periodically) is subject to Social Security taxes; this is called the Social Security Wage Base. This is because, regardless of income, there is a maximum possible benefit that can be paid to anyone receiving Social Security Benefits. That maximum monthly benefit is currently $2,639 for someone retiring at their full retirement age of 66 (this will rise to 67 over the next few years). Receiving this benefit requires earning at least the Social Security Wage Base for 35 or more years. In contrast, a person working full-time at a minimum wage job for 40 years at age 66 gets a monthly benefit of $924.
10. Under some conditions, Social Security benefits are taxable income. When this happens, these income taxes are returned to the applicable Social Security “trust fund” which paid them the benefit, not kept by the Treasury to pay Uncle Sam’s bills. Don’t ask me why.
OK, that’s a rather long overview. Though it hits the major points, it’s missing a fair number of details. So I think you can see already why there are so many varied misconceptions regarding Social Security. It’s complex as hell – and we’ve been lied to about it for years.
What Social Security Is Not.
1. Social Security is not a retirement plan. This is the biggest and oldest lie about Social Security – right up there with “3% of your income” being “the most you will ever pay” (see the paragraph here titled “Your Part of the Tax”). While it was sold as a retirement plan by FDR and his cronies, it is not. You do not own anything. Your payments are not “retirement contributions”; they are legally mandatory taxes you must pay to avoid going to jail. You do not have any kind of “retirement account”, nor are your payroll taxes invested on your behalf. Rather, they’re used to pay benefits to others – currently, with about a 3 year delay between the time you pay them and the time they’re paid out. (In late 1983, that lag was around 2 months.)
What Social Security is is an income transfer program, funded by payroll taxes, that transfers income from those who are working to others eligible by law to receive benefits. Period.
2. Social Security is not property; you own nothing. I mentioned this before, but it merits repeating. Unlike an earned pension, you have no legal property right to receive Social Security benefits because you paid into the system. The SCOTUS ruled that Social Security was a government benefit, not a pension in which you have ownership rights, in Flemming v. Nestor (1960). (You can read the full SCOTUS opinion here.) If Congress wants to change the rules, lower benefits, or terminate the whole Social Security program tomorrow, it can – and you’re SOL. All you did when you paid those FICA taxes was do what was necessary to stay out of jail: obey current tax laws.
3. Your benefits are not guaranteed. Congress can change the rules at any time – and indeed has several times over the life of the program. Just ask anyone affected by the 1970s “notch” – if you can find anyone still alive who was affected, that is. Or you can anyone who’s had to delay retirement due to the rise in Social Security retirement age.
4. You didn’t “pay into the plan” or “earn it”. What you did was pay your taxes as required by law. That’s it. You earned nothing, and there was no “plan” to “pay into”. You pay taxes because the law says you must.
5. Social Security is not “insurance”. Insurance involves paying premiums in exchange for a defined payment in the event a certain event occurs. Social security involves paying taxes required by law, along with – if you’re lucky – getting whatever benefit Congress deems you deserve when you retire or become disabled. Big difference.
6. The “Trust Funds” contain investments that have real value. Not really. As explained above, they’re more like interest bearing checking accounts. They earn little value – not nearly enough to pay annual benefits.
Plus, those “trust funds” are “guaranteed” by Uncle Sam, not by real assets. Uncle Sam is so broke these days that if it cost a quarter to take a dump he’d probably have to upchuck instead if he couldn’t find someone to loan him a nickle.
7. Finally, I’ll say it again: Social Security is not a retirement plan. Bluntly, it’s an intergenerational income transfer program – or in plain language, a means of redistributing income from workers who earn it to others who in general no longer work. In plain language, it’s a welfare program that by design provides an unearned income to elderly and disabled persons as recipients, and is funded by taxes levied on those currently employed.
The Social Security “Trust Funds” – What They Are, and How They Work.
OK, above there’s an overview, followed by a list of some things Social Security is not. So, how does it work? How does the money get from taxpayer to beneficiary? Where does it all come from, and where does it all go?
In what follows, I won’t be addressing Medicare; that also has a trust fund, but though there are some similarities it’s a different beast and appears to be run somewhat differently. I also haven’t researched that one in enough detail to be able to write anything about it that would be reasonably accurate.
The “Trust Funds”. Social Security has two so-called “trust funds”. The quotes are there because in reality, these are merely two temporary holding accounts – or, if you prefer, “laundry bins” or “slush funds” – that allow income to be held temporarily (and earn a bit of interest) before it is spent within a relatively short period of time. These funds are called the “Social Security Old Age and Survivors Trust Fund” and the “Social Security Disability Trust Fund”. (Though it’s technically in the name, I refuse to include the term “Insurance” in the name of either trust fund – because Social Security IS NOT FREAKING INSURANCE, no matter how many times people have lied through their teeth claiming that it is. It’s a damned tax-funded government income transfer program mandated by law; neither payments nor participation are voluntary, and taxes are not insurance premiums.)
While the two funds (Old Age and Survivors, Disability) are distinct, they both operate virtually identically. So a single discussion of how they operate suffices for both.
Income. All income for Social Security is glommed together in the applicable slush funds “trust funds”. It’s held there until it’s needed to pay expenses, at which point it’s spent.
On receipt, this income is used to buy interest bearing “special” Treasury securities. These are different Treasury securities than those available to the public. They generally earn some interest between purchase and redemption.
These sources of income for Social Security’s “trust funds” come in 3 basic “flavors”. The first, and largest, income “flavor” is payroll taxes. This is the 12.4% of all earned income below the Social Security Wage Base (for 2016, that’s $118,500; a history of the Social Security wage base can be found here) that is required to be paid as the OASD portion of the total 15.3% FICA or SECA taxes. Since 2000, of that 12.4% of payroll income roughly 1.8% has gone to the Social Security Disability fund; the rest has gone to the Old Age and Survivors fund.
Yes, I did say 12.4% and 15.3%. That’s not a mistake. If you’re working as a payroll employee, you don’t see that much deducted from each paycheck. However, that’s because payroll employees only pay half of that tax; their employers pay the other half. Self-employed individuals pay SECA taxes vice FICA taxes; these “lucky” folks get boned royally, because they’re responsible for paying that full 15.3% total out of their earned income. (The “extra” 2.90% is Medicare taxes – which are not limited to the first $118,500 of annual earned income. Payroll employees generally only pay half of those as well, with the other half paid by their employer. Self-employed individuals pay the full amount.) In 2015, those OASD payroll taxes totaled nearly $795 billion in income for Social Security, divided between the two “trust funds”.
The Social Security “trust funds” also receive interest from the US Treasury; that’s the second “flavor” of income received by these slush funds. This is the interest earned by those “special” Treasury securities the “trust funds” buy between the time they’re bought with payroll taxes/other income and the time they’re redeemed to pay benefits or expenses. In 2015 that amount was also significant, totaling over $93 billion – again, divided between the two “trust funds”.
The third “flavor” of income for Social Security “trust funds” is payments Social Security receives from the US Treasury’s general fund. Most years, this consists mainly of the return of income taxes paid on the taxable portion of Social Security benefits; those are transferred by the Treasury to the appropriate Social Security “trust fund” vice retained by the Treasury. (As I said previously: do not ask me why this occurs.) There are a few other reasons why the Treasury would transfer money to Social Security (or, even more rarely, where money would flow in the opposite direction). However, with the exception of special reimbursements that occurred in 2011 and 2012, these other reimbursements are generally dwarfed by the other types of Social Security “trust fund” income. (In 2011 and 2012, the Treasury “made up” the 2% temporary reduction in Social Security OASD withholdings by paying the Social Security “trust funds” the difference – which was a huge amount both years.) For 2015, these Treasury payments were around $32 billion – with returned taxes accounting for nearly 99% of that total.
OK, that’s where the money comes from. These “trust funds” thus have their hands in the American taxpayer’s pockets 3 different ways: direct seizure of income (payroll taxes); interest from the Treasury (which taxpayers pay for as well, through other taxes); and diversion of income taxes paid on taxable Social Security benefits that are returned to the fund vice being kept by the Treasury (which taxpayers again must make up through paying other offsetting taxes).
So, that’s where the Social Security “trust funds” get their coin. Where does that money go? Glad you asked.
Expenses. Like income, Social Security has three “flavors” of expenses. The first is Social Security’s own administrative expenses. These currently total somewhere around $6 billion annually, and come out of the “trust funds” vice the Treasury’s general fund. When you’re talking an enterprise that takes in and spends close to $900 billion annually, that’s not really too much in the way of overhead. It’s around 0.67% or so of income.
The second “flavor” is reimbursements to the Federal Railroad Retirement program. By law, Social Security and Part I Railroad Retirement are coordinated, with railroad retirees guaranteed the equivalent of Social Security as their Part I Railroad Retirement benefit. (Part II railroad retirement is funded differently, is optional – and to my understanding is actually backed with some real assets besides Treasury IOUs – just like Social Security should have been funded from day 1.) What that means is that whenever the Railroad Retirement Old Age and Survivor and/or Disability “trust funds” have insufficient income to pay Part I railroad retirement benefits . . . the Social Security “trust funds” transfers them funds to bail them out. That has happened every year but two since 1960 for both railroad retirement Old Age and Survivors and Disability benefits (for railroad retirment Old Age and Survivors benefits, it’s happened every year since 1958). However, this is also a relatively small item; in 2015, that total was less than for admin expenses, coming in at a bit less than $4.7 billion – maybe a bit over 0.5% of income.
The last “flavor” of expense for the Social Security “trust funds” is the “biggie”: benefits payments. In 2015, the combined benefits paid by Social Security for Old Age and Survivors benefits and Disability benefits totaled over $886 billion – exceeding payroll tax receipts by over $91 billion. Only the other two sources of “trust fund” income (interest payments, returned taxes/other Treasury payments) kept the “trust funds” from collectively losing money for the year. Indeed, the Disability fund DID lose money last year – bigtime. In contrast, last year the Old Age and Survivors fund showed a net surplus.
After all is said and done, anything not spent at the end of the year is retained in the “trust funds”. The balance rolls over to the next year. Last year there was a net increase in the OAS fund of around $51 billion. In contrast, the Social Security Disability fund decreased by nearly $28 billion.
Unfortunately, the gap I referenced above between payroll tax receipts and benefits paid is getting larger every year. In the relatively near future, both funds will have more outgo in terms of benefits paid/other expenses than income received from all sources – hell, the Disability fund is already in that state, and has been for several years. When that happens, the “trust fund” concerned spends down its assets to pay those legally-mandated benefits. When the fund balance drops to zero, payments then get dramatically reduced – when that happens, then by law payments will be limited to available income (though it’s unclear if that applies by fund or overall).
Observations Based on the Data – and the “So What”.
1. Many readers may remember the late 1970s/early 1980s “Social Security Crisis”. Yeah, that crisis was real. The Old Age and Survivor’s portion of Social Security damn near went broke.
In the late 1970s and early 1980s, the Social Security Old Age and Survivor’s “Trust Fund” went into a downward spiral. At the end of 1983, the Social Security Old Age and Survivor’s “trust fund” was low enough that it was in real terms less than 2% of today’s balance; it had lost almost half its nominal value (and far more in real terms) from a decade before. It had just over 1 1/2 months of average monthly benefits on hand as a reserve. Since monthly benefits are paid by redeeming securities (and replacing them by immediately repurchasing new Treasury securities with payroll taxes received), this means that the fund was at risk of being unable to pay full benefits if the economy experienced anything but a trivial slowdown. Absent those early 1980s reforms, Social Security would have almost certainly gone Tango Uniform (in terms of paying full benefits due) within a few years. In contrast, at the end of 2015 the Old Age and Survivors “trust fund” had somewhere around 3 years of benefits on balance. (And no – that does NOT mean everything is “Hunky Dory”. Read on.)
2. The Social Security Old Age and Survivors “trust fund” turns over every 3 years or so. It is, in effect, nothing more than a Ponzi scheme that presently has a largish (3 years or so worth of benefits) “slush fund” acting as a 3-year buffer through which to “launder” incoming payments. The fund has nowhere near enough interest and other income annually to pay annual benefits; those incoming payments are thus used, after being held for about a 3 year or so period, to pay benefits. Only what ever is left over after current benefits are paid – today, only a tiny fraction of overall fund income – is retained annually to increase the “trust fund” balance. That ended years ago for the Disability fund. For the Old Age and Survivors fund, that necessary condition (fund increasing annually) for continued operations will be coming to an end pronto.
3. Today’s Social Security “trust funds” are not in any way, shape, form, or fashion funded by tax payments made decades ago. (Remember: the Old Age and Survivors fund was nearly gone at the end of 1983 – and the Disability fund is damn near gone today.) Those payroll taxes from long ago were spent decades ago to provide bennies. Rather, today’s “trust funds” were funded by payroll taxes paid during the past 5 years, give or take – as has historically been the case. Take away income from payroll taxes and the whole thing comes to a screeching halt in about 3 to 4 years, maybe less. And benefits payments keep increasing each year.
4. The Social Security Disability Fund is a “dead man walking”. It will run out of money (e.g., hit zero balance) within 2 years. I’m not sure precisely what happens then; my guess is that either the Old Age and Survivors fund gets tapped to make up the difference, or perhaps disability benefits get temporarily limited to funds received – with the shortage “to be made up later” (yeah, right). Or maybe the Treasury makes up the difference – if it can find anyone to lend it the additional money. Dunno.
However, any of those options is seriously “bad juju”. The Treasury “making up the difference” increases the Federal deficit substantially. The second option cuts bennies substantially for those receiving SSDI benefits. The first accelerates dramatically the coming crash of the OAS fund, which is already projected to occur within 20 years (2035) as it is.
5. Finally: the “so what”. Why do we care about these “trust funds” and how they’re run? How does it affect us?
Here’s why we should care. When Social Security’s “trust funds” are depleted Social Security then reverts to “pay as you go” status, or PAYGO. That means Social Security benefits payments will be limited to that which can be supported by payroll taxes alone. Barring a change, it’s estimated that when that happens in around 20 years, income will at the time support maybe 75% of the benefits that otherwise would be paid. That means everyone receiving Social Security benefits gets a very sudden and (for most) extremely painful 25% financial “haircut”.
“Bad juju,” indeed. We should have listened to folks trying to privatize the system back in the early 1980s.
Unfortunately, we did not. And as a result, to paraphrase the words of Apu Nahasapeemapetilon: “Oh – now (we) are truly screwed!”
