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Social Security is in crisis, and the road to recovery will likely be painful for millions of Americans. To better understand the problem, as well as possible solutions, it helps to take a quick glance back at the program’s history.

The Crisis in a Nutshell

Social Security was created in 1935 as a safety net for the elderly, unemployed and otherwise disadvantaged during the Great Depression. Since then, the basic structure has stayed the same: Retirees draw benefits that are funded by the payroll taxes of employees.

Contrary to popular opinion, Social Security is not self-funding; rather, the balance of the program’s surplus funds ebbs and flows based on two main factors: the number of workers paying into the system and the number of people drawing benefits.

In recent decades, the two trust funds that comprise Social Security’s reserves have benefited from the massive influx of baby boomers to the workforce (see chart). Today, however, as more boomers are retiring, reserves are falling. The effect of COVID-19 has only exacerbated this trend, as skyrocketing unemployment has translated into fewer workers paying into the system and more seniors choosing to claim benefits early. The University of Pennsylvania’s Wharton School now warns that Social Security could run dry as early as 2032. In the absence of significant change, benefits will be cut to 79 percent of existing levels at that time.

The Fix Will Not Be Fun

The formidable task of fixing Social Security lies with Congress, which can either raise taxes or cut benefits to manage the situation. Cutting benefits would be vastly unpopular for lawmakers. Instead, Congress could raise the full retirement age (currently 66 for those born before 1955). This makes sense given that life expectancies have grown significantly since Social Security first began. Congress could also reduce the cost of living adjustment (COLA), which is used to increase benefits annually to keep pace with inflation.

On the tax side of the equation, Congress might elect to increase payroll taxes or expand the benefits that are subject to taxation. Currently, clients earning more than $25k for single filers ($32k married filing jointly) pay ordinary income tax on their Social Security benefits. Congress could also decide to raise funds by increasing the net investment income tax. To date, nothing has been done to address the problem. The longer Congress waits to act, the more extreme the solution will need to be.

Helping Clients Prepare

Assumptions about the future of Social Security often vary by age. A recent study shows 80 percent of millennials don’t expect to receive any Social Security benefits when they retire. Older clients, on the other hand, may be in denial that their benefits will change at all.

Brian Williams, managing principal of G&W Wealth Management in Greenwood Village, Colorado, believes there could come a time when Social Security benefits might not increase with the cost of living. Williams explains, “One of the things I stress with clients is that Social Security could become stagnant in the future, so we have to figure out ways to build inflation protection into their portfolios.”

Sheila Walker Hartwell of Hartwell Planning in New York City says, “None of us has a crystal ball. We don’t know what Congress will do in the future, but we do know the system as it stands today is not sustainable.”

That said, Hartwell does not see a threat to the program’s ultimate survival. “Because such a large percentage of America is dependent on Social Security in retirement, it wouldn’t be in the government’s interest to eliminate the program,” she notes. Nevertheless, Hartwell advises her clients to view Social Security as an important piece of their retirement portfolio, but not their main source of income.

An important message for clients is to stay aware of the actions Congress will inevitably need to take and the impact of those actions on their portfolios. Advisors who can help clients map a course through the changing complexities of Social Security will find they have become an indispensable resource.