Why Is Social Security Running Out of Money?

Social Security serves as a social insurance program in the United States, providing a safety net for millions of Americans. Its objective is to offer income protection against loss of earnings due to retirement, disability, or death, supporting retired workers, individuals with disabilities, and their families. This federal program, known as the Old-Age, Survivors, and Disability Insurance (OASDI) program, is administered by the Social Security Administration (SSA). Over 72 million Americans are expected to receive benefits from Social Security in 2024, highlighting its broad reach.

The Social Security program faces financial challenges, leading to public concern about its long-term solvency. This situation raises questions about the program’s ability to meet future obligations. Understanding these challenges requires examining the system’s funding mechanisms, alongside demographic and economic shifts impacting its sustainability.

How Social Security is Funded

Social Security is primarily funded through dedicated payroll taxes collected under the Federal Insurance Contributions Act (FICA) and the Self-Employment Contributions Act (SECA). Employees and their employers each contribute to Social Security and Medicare through FICA taxes.

For Social Security, both the employee and the employer pay 6.2% of wages, up to an annual limit ($168,600 in 2024). Earnings above this limit are not subject to Social Security tax. For Medicare, both parties pay 1.45% of all wages with no limit. These combined rates result in a total FICA tax of 7.65% for both the employee and the employer.

Self-employed individuals pay SECA taxes, which include both the employer and employee portions of FICA. This means self-employed individuals pay 12.4% for Social Security and 2.9% for Medicare on their net self-employment income, up to the Social Security wage base limit. The Internal Revenue Service (IRS) collects these payroll taxes.

Another, smaller, source of revenue comes from the taxation of Social Security benefits. Depending on a recipient’s combined income, a portion of their Social Security benefits may be subject to federal income tax, with up to 85% taxable for those with higher incomes. The income taxes collected on the first 50% of these benefits are directed back to the Social Security trust funds.

Impact of Demographic Shifts

Changes in population demographics significantly contribute to the financial pressures on Social Security. These shifts alter the balance between those contributing to the system and those receiving benefits. Declining birth rates mean fewer new workers are entering the workforce to support the growing number of retirees.

The U.S. fertility rate has declined over several decades, falling below the 2.1 rate needed to maintain a population without immigration. This results in a smaller future workforce relative to the retiree population, leading to fewer contributors per beneficiary.

Increased life expectancy means people are collecting Social Security benefits for more years. Life expectancy at birth in the U.S. has risen considerably, and at age 65, individuals live longer than when Social Security was established. This longevity adds to the overall payout burden on the system.

The retirement of the large Baby Boomer generation (born 1946-1964) further intensifies these demographic pressures. This generation began reaching retirement age in 2008, and by 2031, all will be at least 67. This substantial increase in beneficiaries, without a corresponding rise in the contributing workforce, creates a significant imbalance.

These demographic trends collectively lead to a rising “dependency ratio,” which measures the number of individuals considered dependent (typically those under 15 or over 64) relative to the working-age population (ages 15-64). A higher dependency ratio indicates that fewer workers are available to support more retirees. The aged dependency ratio, specifically comparing those over 65 to working-age individuals (20-64), is projected to increase from 35 per 100 workers in 2014 to 44 per 100 workers by 2030, illustrating the growing strain on the Social Security system.

Economic Pressures

Beyond demographic shifts, several economic factors also exert pressure on Social Security’s financial standing. These economic dynamics influence both the income generated by the system and the payouts it must make. The rate at which wages grow directly impacts the amount of payroll tax revenue collected.

Slower growth in average wages can limit the expansion of payroll tax revenues. Social Security taxes are directly tied to earnings, so if wages stagnate, the tax base does not expand as quickly as needed to keep pace with rising benefit obligations. This reduced growth in contributions creates a shortfall in the system’s income compared to its expenditures.

Inflation also plays a role in increasing the program’s costs. When inflation rises, the cost of living adjustments (COLAs) applied to Social Security benefits increase to help beneficiaries maintain their purchasing power. These higher COLAs lead to larger benefit payouts from the system, placing additional demands on its financial resources.

The interest rates earned on the Social Security Trust Funds’ investments also affect the program’s income. The Trust Funds are invested in special U.S. Treasury securities, and the interest generated from these investments contributes to the system’s overall revenue. In periods of low interest rates, the revenue stream from these investments can be reduced, further constraining the program’s financial capacity.

Unemployment rates can temporarily impact Social Security’s funding. During periods of high unemployment, fewer individuals are earning wages subject to FICA and SECA taxes. This reduction in the contributing workforce leads to a decrease in payroll tax collections, creating short-term revenue challenges for the system.

The Social Security Trust Funds

Understanding the financial state of Social Security requires a clear grasp of its trust funds. The Social Security Trust Funds consist of two distinct accounts: the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund. These are not traditional investment accounts holding stocks or bonds but rather accounting mechanisms that hold reserves for future benefit payments.

The funds hold special non-marketable U.S. Treasury securities. These securities are essentially IOUs from the U.S. government, backed by its full faith and credit. When annual tax revenues exceed the amount needed for current benefit payments and administrative costs, the surplus is invested in these special government securities, and the amount is credited to the trust funds. Conversely, when outlays exceed incoming tax revenues, the Social Security Administration redeems these securities to cover the difference, drawing upon the accumulated reserves.

The phrase “running out of money” for Social Security often leads to misconceptions. It does not mean the program will cease to exist or be unable to pay any benefits at all. Instead, it refers to the projected depletion of the reserves held within these trust funds. Even after these reserves are depleted, Social Security would still be able to pay a significant portion of scheduled benefits from the ongoing payroll tax contributions it continues to receive.

The Social Security Administration (SSA) issues annual Trustee Reports that provide projections on the financial health of these funds. According to the 2024 Trustees’ Report, the combined OASI and DI (OASDI) Trust Funds are projected to be able to pay 100% of scheduled benefits until 2035. After that point, if no legislative changes are made, continuing program income is expected to be sufficient to pay approximately 83% of scheduled benefits. Specifically, the OASI fund alone is projected to be depleted by 2033, after which it would be able to pay 79% of benefits, while the DI fund is projected to remain solvent through at least 2098.