Know the Pitfalls of COVID-19 on Your Social Security

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Know the Pitfalls of COVID-19 on Your Social Security

The economic fallout from COVID-19 has been unprecedented. With tens of millions newly unemployed, and with the U.S. GDP contracting at a record rate in Q2 2020, the financial peril of Social Security is becoming more evident.

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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What About COVID-19?

Shockingly, none of these projections reflect the actual and potential effects of COVID-19 on Social Security. According to the New York Post, by the beginning of July 2020, roughly 50 million Americans had already filed for unemployment benefits due to the lockdown, leading to a collapse in consumer spending and an explosion in government deficits. All segments of the economy were impacted.

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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What the Government Can Do to Keep Social Security Alive

Absent a radical rethink of government programs in general and Social Security in particular, there are a few ways policymakers can keep the program alive (or kick the can further down the road). The first, most obvious, and least popular options are raising taxes and cutting benefits. The political ramifications of these measures could be stiff, especially considering the recent tax cuts by the Trump administration. States that have seen their revenues plunge are also unlikely to fill the gap.

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.

Learn more about retirement-related topics and trends on our Retirement Channel.

The Bottom Line

The COVID-19 pandemic has exposed many of the apparent shortfalls of Social Security. Unfortunately, the options for ensuring entitlements are limited and wrought with political obstacles. It may be time for individuals to take retirement planning into their own hands and start planning at a much younger age.

Be sure to check our News section to keep track of the latest updates from the mutual fund industry.

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Aug 12, 2020