Social Security is a critical program in the United States

This post will talk about who relies on Social Security, how your benefits are calculated, how much income the program is designed to replace, and the financial condition of social security.

It saddens me that Congress cannot act like adults and make bipartisan changes to this important program. I am pretty sure they will come together 3-6 months before the program cannot pay full benefits and do something very similar to what was done in

1983 and it will again be very unpopular.

Who relies on Social Security in retirement?

The most recent data I have seen is from the Social Security Administration (SSA) itself. It was published in 2021 based on 2015 data. Per the SSA using 2015 data:

Social Security Benefits represent about 30% of the income for people over age 65. Note this means the program is working as expected since a lot of people are working after 65 due to increases in life expectancy.

51.8% of those aged 65 or older rely on Social Security for half or more of their income.

24.7% of those aged 65 or older rely on Social Security (SS) for 90% or more of their income. This is a very serious problem.

The percentage of reliance on Social Security by IRS income quintile is terrifying. The 1st quintile is the lowest income 20% of income tax returns filed.

For the 1st quintile, 86.6% rely on SS for half or more of income and 64.1% rely on it for 90% or more of income.

For the 2nd quintile, 82.3% rely on SS for half or more of income and 47.8% rely on it for 90% or more of income.

For the 3rd quintile, 62.7% rely on SS for half or more of income and 13.8% rely on it for 90% or more of income.

For the 4th quintile, 24.8% rely on SS for half or more of income and 1% rely on it for 90% or more of income.

For the 5th quintile, 2.2% rely on SS for half or more of income and none rely on it for 90% or more of income.

There is zero chance Congress can allow Social Security benefits to be cut unless it is only for the very wealthy and I do not think they should even do that. Instead, taxes and the retirement age will be raised and this will likely happen in 2035 because Congress never plans and waits until we are in crisis to fix anything like this. Their fix will be wildly unpopular. Note if fixed today the results would be less draconian…

How are Social Security benefits calculated?

It saddens me how few people understand this. This should be emphasized in K-12, in college, by employers, and by the government itself.

I am very angry the Social Security Administration largely stopped mailing statements in 2011. I really think this was criminal. Everyone should know what their expected social security benefits are and I think annual statements should be mailed. Further the statements should emphasize the long-term fiscal insolvency of the program. Please go and setup an online account and check it every year on your birthday.

First off, the social security benefit formula is progressive, meaning those who make less have a much higher percentage of their income replaced in the form of benefits. The Social Security program was designed to benefit lower income individuals and it does that. Further in 1983 up to 85% of social security income became taxable to the Federal government depending on other income and this makes the program even more progressive. Note I have clients who complain about this every year and the law was passed 41 years ago.

You qualify for Social Security benefits if you accumulate enough credits. The amount needed for a credit in 2024 is $1,730. You can earn up to a maximum of 4 credits per year. The amount needed to earn 1 credit automatically increases each year when average wages increase.

Your benefits are calculated based on your average indexed monthly earnings (AIME), your primary insurance amount (PIA), and the age at which you choose to receive benefits.

Your AIME is a calculation based on your 35 best years of income subject to social security tax. The SSA indexes your income subject to social security tax and adjusted each year for inflation. You get credit for your best 35 years indexed to inflation. Any additional years of income are lost and not included in the calculation. If you do not have 35 years of income then zeros are averaged in. AIME is your average MONTHLY earnings subject to social security tax, indexed for inflation, over your best 35 years of earned and best is best in inflation adjusted terms.

Note this calculation covers your entire life. It is very difficult to change these numbers.

Those of you who own Subchapter S Corporations may well have less in benefits at retirement depending on how much you are paid in wages each year. That is OK as long as you invest the savings due to being an S Corporation.

If you are retiring this year, and your average annual income subject to social security tax is $72,000 in 2024 dollars your AIME is $6,000.

The next part of the calculation is what benefits low-income earners and makes the program progressive. Note with the demise of defined benefit retirement plans the program needs to be progressive.

Next your Primary Insurance Amount (PIA) is calculated and the formula changes every year due to inflation.

For 2024, your PIA will be the total of: 90% of the first $1,174 of your AIME Plus, 32% of any amount over $1,174 up to $7,078, Plus15% of any amount over $7,078. This is rounded to the nearest dollar.

If you retire in 2024 and your AIME is $6,000, your PIA is: 1056.5 + 1,544.32 = $2,601. So, you are paid $2,601 if you retire at full retirement age minus what you pay for Medicare premiums.

For planning purposes in 2024 you clearly want an AIME of at least $1,174 since you get 90% of this amount in the PIA calculation. Next you might want to have an AIME of $7,078 because above $7,078 you only get 15%.

You should go online, setup a social security account and look at your lifetime earnings. Make sure they are correct. Far easier to fix now rather than later.

Remember income subject to social security tax is not all income. Interest, dividends, S corporate profits, etc. is NOT subject to social security tax and does not count in this calculation.

Your PIA is the benefit you will receive if you are at full retirement age. If you start drawing benefits early you will get less and if you wait until age 70 you will get more. This is something you need to consider carefully and it is more complicated if you are married. Please analyze this carefully when you start drawing benefits. It is extremely important. Too many people draw benefits too early.

Social Security has great calculators online and you really should setup a social security account today.

How much income is Social Security designed to replace?

Social Security was passed into law in 1935. The program was designed to replace 1/3 of a worker’s income in retirement. The life expectancy in the United States in 1935 was 62. Today it is 79. This is the primary reason the Social Security program is in financial trouble. Life expectancy has increased by 17 years!

The original Social Security documents talk about a three-legged stool where 1/3 comes from SS, 1/3 from employer defined benefit plans, and 1/3 from savings.

Defined benefit plans are no longer common. The government did a terrible job ensuring companies properly funded them. Further, private businesses realized they were expensive and switched to plans where employees contribute. This shifted a significant amount of retirement planning onto individuals.

Note I do a lot of tax returns for retirees with defined benefit pension plans. Each year fewer and fewer people will receive retirement benefits from defined benefit plans.

The last major changes to Social Security were made in 1983 and were very bipartisan. Further they were very unpopular. Social Security could not have paid full benefits in late 1983 and changes were made that will extend the program solvency to about 2035.

The Social Security funding formula was changed in 1983 and the program was changed to replace 40% of income subject to social security tax rather than 1/3 of total income. Note, actuarily the program is designed to replace as much as 55% of income for the working poor and 20-25% for those who earn close to the annual Social Security wage cap. Note the program replaces far less than 20% for very high earners.

Note many financial planners say that you need to replace 80% of your total income in retirement (Not income subject to social security taxes). Social Security is designed to replace 40% of your income that was subject to social security taxes. For people at the lower end of the income spectrum a much higher percentage of their income is subject to social security taxes.

The financial position of Social Security is grim and projected to get a little worse over time. According to the 2024 Social Security Trustees Report with no changes to the program the following benefits will be paid out:

Through 2034 100% of benefits paid

2035 83% of benefits paid

2098 73% of benefits paid

Under current law if changes are not made benefits are cut across the board. This is built into existing law and would take an act of Congress to change.

There are many ways to fix the solvency of Social Security program; however, Congress will not get off their behinds and come up with a bipartisan solution to fix the problem until 2035. Anything Congress does will be deeply unpopular and that is why they will do nothing until the crisis is at hand.

What irritates me is Social Security is a very necessary program and the sooner it is brought into solvency the better. The sooner changes are made the less drastic they need to be. Yet Congress does nothing except both sides bring up extreme ideas and attack each other.

Per this report, the easiest way to fix the solvency of the program for the next 75 years is to increase Social Security payroll taxes from the current 12.4% (Half paid by employer) to 15.8% (Half paid by employer). If this change was made as of 1/1/25 the Social Security program would be solvent and able to pay full benefits through 2098.

This would increase employer payroll costs by 1.7% on all wages up to the Social Security cap. Further it would decrease employee pay by 1.7% on all wages up to the Social Security cap. The self-employed would have to pay 3.4% more since they pay both sides. This will never happen because members of Congress have no spine.

Younger Americans are convinced they will not receive Social Security benefits when they retire or at least think they will get less than the promised amount.

Older Americans vote. All members of Congress care about is getting re-elected. There is zero chance Congress is going to allow benefits to be cut. That being said, the changes Congress has to make will be very unpopular.

If I had to guess, and this is a total guess, I think something like the following will happen in 2035, and which major political party is in power will influence this and this guess assumes divided government which is what we generally have.

I think the retirement age to collect Social Security will be increased. Life expectancy is up 17 years from when the program was started. I think early retirement age will be slowly increased to 65 from 62. I think full retirement age will be slowly increased from 67 to 70. Note these changes will be deeply unpopular and the AARP will go berserk. The Democrats will oppose this and the Republicans will insist on it. Note this change would fix 45% of the 75-year funding shortfall. In the end, this is cutting benefits.

Payroll taxes honestly need to be increased. Back in 1983 Social Security taxes were 10.8% (Half employee and half employer) and over the next seven years they were slowly increased to 12.4%. They have been 12.4% since 1990. I might guess they increase them by another 1.6% in total, half employee and half employer. Likely done over an 8-year period. The Chamber of Commerce and NFIB will go berserk. Republicans will oppose this and Democrats will insist on it. Note this change would fix 45% of the 75-year funding shortfall. In the end this is raising taxes.

Note the above two paragraphs are very reasonable compromise.

The other 10% of the funding shortfall would be fixed by a large number of minor changes. Maybe instead of making Social Security income 85% taxable they will just make it taxable 100%. Maybe they will adjust the benefits formula so the annual benefit increases are less. Maybe they will increase the social security wage cap.

If we do not have divided government then the fixes will be more extreme with the Republicans cutting benefits more if they are in power and the Democrats raising taxes more and means testing benefits.

Social Security benefits are vital. Congress has failed entirely to ensure this program is sufficiently funded.

We highly suggest our clients communicate with their CPA before they draw social security benefits.

If you have specific questions about Social Security benefits you can talk to your CPA! Plenty of our clients hire us to help with Social Security planning and I particularly enjoy doing it.

Mike Sylvester, CPA