For mutual fund investors, taxes are inevitable. Even if you’re a long-term buy...
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Social Security was facing a major shortfall long before COVID-19, but the pandemic has accelerated the trend. A 2020 trustees report concluded that the cost of Social Security will exceed income beginning in 2021.
As Baby Boomers exit the workforce, the number of Social Security beneficiaries grows significantly. They are being replaced by lower birth rate generations in the Gen-X and Millennial categories. For Social Security, that means net inflows will turn negative as the ratio of workers paying taxes to beneficiaries receiving payments declines.
Even when the effect of the Baby Boomer exodus stabilizes after 2040, the annual costs of Social Security will continue to rise faster than income, according to the trustees’ report.
Reserves are drying up across the board. The Old-Age and Survivors Insurance Trust Fund (OASI), which distributes retirement payments, will be unable to meet its full obligations by 2034. Without new legislation, OASI will have enough tax income to distribute only 76% of scheduled payments.
Meanwhile, the Disability Insurance Fund will have enough money to cover 92% of its scheduled benefits. Its reserves are expected to be depleted in 2065, the report claims.
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With millions out of work, Social Security loses its biggest funding mechanism: payroll tax contributions. In 2019, payroll tax deductions funded nearly 89% of the Social Security program.
The pandemic triggered a synchronized response from all levels of government and the Federal Reserve. For the Fed, the first act of business was to slash interest rates to zero. For Social Security’s asset reserves, that means a reduction in net interest income.
With the economy in lockdown, immigration has also taken a hit. The gap between Baby Boomers and subsequent generations is being filled by a steady stream of legal immigrants who work and pay taxes in the United States. With this avenue drying up, especially for skill-based immigration programs, Social Security could face an even bigger shortfall.
Let’s also not forget that government inflation measures tell us consumer prices are declining amid the recession. The Consumer Price Index for Urban Wage Earnings and Clerical Workers (CPI) is used to determine Social Security’s annual cost-of-living adjustment (COLA). With official inflation metrics in decline, COLA could stagnate or flat-line in 2021.
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Pension funds can also shift their portfolio allocation to hedge funds, private equity, and other volatile assets. However, there’s no guarantee this method will improve risk-adjusted returns.
If the trust fund continues to dry up, Social Security benefits may shift entirely to the Treasury. The downside (other than fiscal) is that Social Security would no longer be protected from the political process.
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