The Social Security Trust Fund actually comprises two funds: the Old-Age and Survivors Insurance (OASI) and the Disability Insurance (DI) trust funds. The OASI trust fund provides benefits to retired workers and family members of deceased beneficiaries, while the DI trust fund provides benefits to disabled workers and their dependents. Both accounts are managed by the U.S. Treasury and funded primarily by payroll taxes.
In this article, we'll examine how the Social Security Trust Fund works, learn more about the history of these accounts and their current problems, and look at ways to stabilize Social Security in the future.
What Is the Social Security Trust Fund?
The Social Security Trust Fund is America's retirement fund, as well as a source of benefits for the blind and disabled. In February 2021, over 69 million Americans received some Social Security benefit.
The U.S. Treasury Department manages the trust funds under the direction of a six-member board. Each year, the board reports to Congress on the financial and actuarial status of the trust funds.
How the Social Security Trust Fund Works
Three sources of income fund Social Security: payroll taxes, interest on excess funds held by the Treasury, and taxes on benefits for current beneficiaries.
Payroll taxes are the primary source of funding for the trust funds. Workers and their employers each contribute 6.2% of their pay, up to the taxable maximum for the year, which is $142,800 for tax year 2021. Self-employed workers pay the full contribution of 12.4%.
In 2019, the most recent year for which data is available, 89% of Social Security funding came from payroll taxes. The rest came from interest on the fund's securities (7.6%) and taxes on benefits (3.4%).
History of the Social Security Trust Fund
On August 14, 1935, President Franklin D. Roosevelt signed into law the Social Security Act. The law created a program to pay an income to retired workers age 65 or older. The funds for Social Security came from payroll taxes, known as "FICA." The Social Security Trust Fund was established in 1937 to manage the income collected from these taxes so they could be redistributed as Social Security Income.
Since then, the fund has received more in income than it's paid out in benefits. That's because of America's demographics. Until recently, there were at least 2.9 workers for every beneficiary. More money has gone into the fund via payroll taxes than has gone out as benefits. It's also been because of tax hikes and adjustments to benefits. In 1977, the payroll tax rate was raised from 6.45% to 7.65%. The trust fund has held a surplus since then.
The fund also receives interest income from its investments in "special issue" securities. The rate of return is determined by a formula enacted in 1960, and it changes each month. The average monthly rate in 2019 was 2.219%, but the average rate for all $2.9 trillion in fund assets was 2.812%. The fund still holds bonds from past years when interest rates were higher.
At the end of 2019, the Social Security Trust Fund had reserves of $2.9 trillion.
Does Congress Raid Social Security?
The U.S. Treasury must invest Social Security income in "securities guaranteed as to both principal and interest by the federal government." It issues "special issue" securities for use by the trust funds.
There are three differences between these special issue securities and U.S. Treasury bonds: they are not tradable, they are only available to the trust funds, and they are only bought with payroll taxes. The Treasury redeems these bonds, with interest, to pay for benefits. The money to redeem the bonds comes from the General Fund.
After that, the payroll taxes go into the General Fund, where they pay for government expenditures. That's how presidents "borrow" money from the Social Security Trust Fund. The borrowed funds make their deficits look smaller. The real amount owed still shows up in the national debt. It explains why the U.S. debt by president is larger than the U.S. deficit by president.
For this reason, the Heritage Foundation says that the "special issue" securities are "nothing more than IOUs." That's because future benefits will have to come from "taxes that are being used today to pay for other government programs."
Solvency of Social Security
For years, the Board of Trustees warned that the demographic changes that created the surplus would also lead to the fund's demise. As the baby boomers turn 65 and start to retire from the workforce, there will be fewer workers supporting more retirees. That will increase the age dependency ratio.
The financial crisis of 2008 hastened this trend. Higher unemployment meant even lower payroll tax income. In 2010, the Obama tax cuts reduced the OASDI payroll taxes by 2%, while extending the Bush tax cuts. In fact, that was the first year that income from payroll taxes was not enough to cover benefits. The fund only received $544 billion from payroll taxes but paid out $577 billion in benefits. But its other income, from investments and taxes on the benefits, more than covered its costs.
The fiscal cliff deal ended the 2% payroll tax holiday. Obamacare taxes on high-income households also began in 2013. That increased revenue to the fund and improved its cash flow shortfall. But the Tax Cuts and Jobs Act reduced taxes again. In 2021, total costs will begin to exceed total income, according to the 2020 Social Security Annual Report.
The Social Security Administration currently projects that the OASI Trust Fund will be able to pay full benefits until 2034, at which time it will be able to pay 76% of full benefits. The DI Trust Fund is projected to pay full benefits until 2065, at which time it will be able to pay 92% of full benefits.
Fixing Social Security
There have been a number of different proposals to restore Social Security solvency. Most focus on one or more of these factors: decreasing benefits paid, increasing taxes, or increasing debt. Since the debt is already unsustainable, policymakers are forced to choose between a tax increase or a benefit decrease.
Here are a few examples of changes that could stabilize the trust funds:
- Raise the retirement age. Raising the full retirement age to 69, and then indexing to longevity, would close 34% of the shortfall, according to a calculator from The Committee for a Responsible Federal Budget.
- Increase payroll taxes. Raising the payroll tax by 3.14% to 15.54% would increase revenue sufficiently to close the gap.
- Eliminate the taxable maximum. Social Security taxes earnings up to a given limit, which changes each year. In 2021, the earnings limit was $142,800. The same limit applies to benefits received. By eliminating the taxable maximum, but retaining the cap on benefits, the trust funds would remain solvent for more than 40 years.
- According to current projections, the Old-Age and Survivors Insurance Social Security Trust Fund will be able to pay full benefits until 2034, at which point it will be able to pay 76% of benefits.
- The shortfall would be mostly due to changes in demographics. The fund is supported primarily with payroll taxes, and there is a decreasing number of workers supporting retirees.
- Social Security solvency could be restored using a number of different methods, including raising the retirement age, increasing the payroll tax, or reducing or eliminating the taxable maximum.