Social Security: Benefits and Funding

1
Social Security Benefits and Funding

• Gregory Krohm
• April 23, 2008

2
Overview

• Brief review of history and founding principles
  of Social Security Act
• Overview of all SS benefits and rationale or
  presumed need
• Will focus on retirement benefits
• eligibility
• benefits
• their cost to SS program
• Sources of funding
• Fiscal condition of SS and reform proposals
• Medicare coverage, funding, and fiscal condition

3
Founding Principles

• Three principles should be observed in
  legislation on this subject.
• First, the system adopted, except for the money
  necessary to initiate it, should be
  self-sustaining in the sense that funds for the
  payment of insurance benefits should not come
  from the proceeds of general taxation.
• Second, excepting in old-age insurance, actual
  management should be left to the States subject
  to standards established by the Federal
  Government.
• Third, sound financial management of the funds
  and the reserves, and protection of the credit
  structure of the Nation should be assured by
  retaining Federal control over all funds through
  trustees in the Treasury of the United States.
  ----- FDR message to Congress, Jan. 1935
• In addition to old-age benefits the first SS
  Act proposal included a wide variety of other
  social protection
• Unemployment compensation.
• Aid to states for benefits to needy children
• Public health service and insurance

4
Founding Principles

• In signing the Social Security Act on August 14,
  1935, Roosevelt said
• We can never insure one hundred percent of the
  population against one hundred percent of the
  hazards and vicissitudes of life, but we have
  tried to frame a law which will give some measure
  of protection to the average citizen and to his
  family against the loss of a job and against
  poverty-ridden old age.
• the Act represents a cornerstone in a
  structure which is being built but is by no means
  complete
• later he noted the Act constituted a pioneer
  effort on the part of the Federal Government, but
  although it was comprehensive in scope we
  recognized that it would have to be developed
  with experience

5
Legislative Milestones

• 1935 At first SS was a retirement plan, i.e.,
  Old Age Benefits
• 1939 Became Old Age and Survivors Insurance
• 1939 Benefits became first payable in 1940,
  instead of 1942 as originally planned
• 1956 Social Security Disability Insurance
  created
• 1965 Medicare added
• 1972 Big benefit increase and future increases
  indexed to CPI
• 1983 Rescue Legislation to stop impending
  default on benefit checks by raising taxes and
  cutting future benefits

6
SS Basic Factssee http//www.ssa.gov/pressoffice
/basicfact.htm
7
Overview of OASDI Benefits

• Old age retirement
• Survivors benefits
• Disability benefits
• Supplemental Security Income
• more of a transfer program than social insurance

8
Old Age

• Retirement annuity paid monthly
• Payments made to
• Worker earning coverage
• Spouse
• Dependent children
• Dependence ends at child attains certain ages
• Ex-spouse

9
Survivors

• Essential life insurance
• Paid monthly instead of lump sum
• Half of retirement benefit
• Paid to
• Spouse at old age or disability
• Dependent children

10
Disability

• Triggered by very strict standard of disability
• Monthly benefit equal to retirement benefit
• Paid to disabled worker
• Dependents of worker

11
Wage Credits the Building Blocks of Coverage

• Credits are the "building blocks" of the minimum
  amount of covered work to qualify for each type
  of Social Security benefits
• Credits are cumulated over a lifetime
• If a person stops working at any time the credits
  earned to date are banked
• The earnings amount needed for a credit is
  indexed (changes each year).
• In the year 2005, 920 in covered earnings to get
  one Social Security or Medicare work credit and
  3,680 to get the maximum four credits for the
  year
• No benefits can be paid if you do not have enough
  credits
• However, extra credits over the minimum do not
  increase your benefit amount

12
Insured Status

• The number of quarters of contributions to SS
  controls eligibility
• Three status classes control eligibility for
  benefits
• Fully insured
• 40 quarters of coverage for retirement
• Triggers retirement and some survivor benefits
• Currently insured
• Disability insured
• Special rules for becoming eligible for
  disability income
• Liberalized rules for young workers and the blind

13
Allocation of OASDI Payments

• Most benefits go to retirement
• Survivors benefits actually declining since 1995

14
Retirement Benefit

• The first and only benefit in 1935
• Creates a minimum base for retirement income
• Presumed need
• No tests of need or financial thresholds

15
Persons Getting Retirement Benefits

• Retired Worker
• Spouse of Retired Worker
• Unmarried Children lt18
• Special provision for disabled
• Qualifying ex-spouse of worker

16
Size of Retirement Check

• Benefit check (for retiree and spouse) is based
  on
• How much a person earned (SS taxable) during
  their career
• Age at which you retire

17
Benefit Amounts

• All monthly income based on Primary Insurance
  Amount
• Retirement or disability benefits
• Avg. Indexed Monthly Earnings (AIME)
• Designed to keep benefits at inception a constant
  portion of earned income
• Primary Insurance Amount Formula
• Three step scale of lower benefits for higher AIME

18
Adjustments to PIA

• Automatic Cost of Living
• One of the few inflation guarantees in the
  economy
• Delayed Retirement Credit
• Incentive to delay retirement and ease net drain
  on trust fund
• Special Minimum Benefit
• Protects chronically underemployed workers
• Maximum Family Benefit
• Cap on benefits to large family of beneficiaries

19
Calculation of Benefits

• Begin with workers average indexed monthly
  wage (AIME).
• Index each years past earnings for wage growth.
  (This effectively pays interest at the rate of
  wage growth, around 1 percent.) Years after age
  60 are not indexed.
• Select 35 highest earning years and add together.
  
• Divide the sum by 35 (to produce an annual
  average), then by 12 (to produce a monthly
  average).
• Adjust monthly AIME amount by stair step formula.
• Credit 90 percent of the first 592 of workers
  AIME,
• plus 32 percent of earnings between 592-3,567,
• plus 15 percent of earnings above 3,567.
• This produces a primary insurance amount (PIA).
• PIA is the basis for monthly benefit checks to
  worker, and the basis for spousal, disability and
  survivors benefits.
• Source

http//www.ssa.gov/OACT/COLA/Benefits.html
20
Benefits Indexed to CPI
21
Benefits to Spouse of Retiree

• Spouses with low lifetime earnings can collect up
  to half of the retirees full benefit
• If the spouse can claim benefits on their own
  work record, SS pays the individuals own benefit
  first, before the spouses benefit
• If your benefit as a spouse is higher than you
  own retirement benefit, you will get the higher
  spousal rate
• Divorced spouse can get benefits
• Married gt 10 yrs and still unmarried

22
Role of SS Benefit in Overall Retirement Funding

• Under current law, if you have average earnings,
  your Social Security retirement benefits will
  replace only about 40 percent.
• The percentage is lower for people in the upper
  income brackets and higher for people with low
  incomes.
• You'll need to supplement your benefits with a
  pension, savings or investments.
• Source SS Admin website

23
Overview of Funding Sources
Source 2006 Trustees Report, http//www.ssa.gov/
OACT/TRSUM/tr06summary.pdf
24
Employer Tax

• Covered employers are obliged to report all
  covered wages to the SSA
• SSA receives 250 million employer wage reports
• The employer reports are matched to individual
  wage earners

25
Employer Tax

• The OASDI portion of FICA tax rate is
• 6.2 from the employer
• 6.2 from the employee up to the wage cap
• There is a maximum amount of earnings (wages and
  net profit from self-employment) on which you pay
  Social Security taxes each year.
• It is indexed and changes each year
• For 2006, the maximum amount will be 94,200
• 90,000 in 2005
• About 10 percent of wage earners are limited by
  the current cap
• The Medicare portion of FICA is 1.45
• does not have a wage cap

26
Federal Income Tax Contribution

• Some people have to pay federal income taxes on
  their Social Security benefits.
• usually only if other substantial income (such as
  wages, self-employment, interest, dividends
  reported on your tax return) in addition to
  benefits
• E.g. individual with 25,000 and 34,000 pays
  income tax on 50 percent of benefits
• no one pays federal income tax on more than 85
  percent of his or her Social Security benefit
• This income tax revenue is earmarked by the IRS
  for the SS trust fund

27
Social Security Taxation Fairness

• The SS payroll tax is the largest personal tax
  paid by millions of workers
• It is the regressive form of taxation by the
  federal government
• For 90 percent of the workers the tax is a flat
  percentage
• For the richest 10 the average rate is lower than
  the remainder of workers

28
Benefit Discrimination

• There is little correspondence between taxes paid
  and benefits received for any class of
  participant
• Women receive several significant advantages and
  disadvantages
• In general groups with lower life expectancies
  are hurt
• African American men live six years less than
  white men

29
Benefit Discrimination

• There appears to be a transfer of wealth from
• Highest income workers to low income workers
• The older age cohorts are receiving huge net
  subsidy from younger workers

30
Compute Your Rate of Return
http//www.heritage.org/research/features/socialse
curity/SSCalcWelcome.asp
31
ROI for this Class(Based on Heritage Model)

• Return on lifetime tax payments
• Females .57
• Males -.82

The model has been criticized as making overly
pessimistic assumptions
32
Fiscal Crisis

• In 1980, Social Security's Board of Trustees
  reported
• a 1979 deficit of almost 2 billion
• that by 1982 at the latest OASI insurance would
  be unable to pay benefits on time
• by calendar 1985 Social Security's trust fund
  would be exhausted
• This was a very clear and present danger to the
  solvency of the system and benefit payments
• The fiscal problems of SS are worsened by
• Poor fiscal condition of Medicare
• Deficits in general federal budget
• For more insight on the debt crisis, see
• 1) Bernanke warning
• http//www.bloomberg.com/apps/news?pid20601087si
  da_46QcGbvFZkreferhome
• 2) Broder critique of Bush 2007 budget
  http//www.concordmonitor.com/apps/pbcs.dll/articl
  e?AID/20070214/REPOSITORY/702140375/1043/48HOURS

33
Fiscal Crisis Greenspan Commission

• In Jan 1983 the Commission issued a report
• Just in time--benefit checks would be delayed in
  July 1983 because of fiscal meltdown
• Report resulted in emergency legislation to fix
  the impending crisis

34
Fiscal Crisis Greenspan Commission Fix

• Elements of the fix
• Increase tax on self employed
• Scheduled tax increase were accelerated
• COLA increase delayed for six months
• The only pain of reform for existing
  beneficiaries
• Income taxation of SS benefits
• Advancing retirement age
• Many new groups added to SS system
• Produced over half the fix to the actuarial
  deficit
• Lessons from Greenspan Commission
• Deferring problems to prominent commissions is a
  classic political strategy
• Reforms fall lightly on present beneficiaries
• Workers in the distant future are easier targets
  for bearing the pain

35
Medicare

• Comprehensive medical insurance for
• those over 65 years of age
• certain seriously disabled people
• Provides comprehensive benefit financing
• Services provided through private medical
  suppliers
• Federal government set rules, collects taxes, and
  pays medical providers

36
Medicare

• Medicare costs are rising very rapidly
• Causes
• Increased expensive treatment options
• Aging of the population
• Longer life expectancy
• Medicare is a pay as you go system
• General federal tax revenues will have to fill an
  ever increasing gap between costs and Medicare
  contributions

37
Summary Social Security

• SS offers three classes of benefits
• Retirement, survivor, and disability Throughout
  its history SS has been politically volatile
• Eligability has been based on presumed need for
  certain categories of households
• SS is nearly a pay as you go system
• Congress had tended to increase benefits without
  regard to funding
• Returns to participants vary greatly by time of
  retirement, gender, and earnings
• Since the 1983 Commission, get tough reforms
  have been tried
• Facts have been poorly understood by the public
• Present beneficiaries ALWAYS get a pass on the
  pain of reform while future workers bear the
  consequences

38
Summary Medicare

• Medicare is automatic health insurance for
• those over age 65
• certain people with serious disabilities
• Costs have been growing very rapidly
• Advances in medical treatment options, aging
  population
• Medicare is a pay as you go system
• Same tendency in Congress to offer more benefits
  without funding
• Medicare deficit is projected to be far worse
  than SS deficits, with no end in sight.