Definition: The Social Security Trust Fund is actually a combination of two funds: the Old-Age and Survivors Insurance (OASI) and the Disability Insurance (DI) Trust Funds. Although Social Security is known primarily as a retirement fund, it also disburses benefits for the blind and disabled. By 2011 (latest figures available), one in seven Americans (50 million) received some kind of Social Security benefit. Nearly all (90%) workers paid Social Security taxes.
How Does the Fund Work?
The Trust Fund is managed by the Department of the Treasury, and overseen by a six-member Board. As payroll tax income comes into the Treasury each day, it is required by law to be invested in "securities guaranteed as to both principal and interest by the Federal government." This used to be ordinary, marketable Treasury notes whose value changed depending on demand in the secondary market. Therefore, Treasury created "special issue" securities that guarantee amount of the principal and interest no matter when they are redeemed, regardless of market conditions. Unlike Treasuries, they are only available to the trust funds. Benefits are paid out of the redemption of these "special issue" securities.
The payroll tax income itself goes into the General Fund. For this reason, some critics say the "special issue" securities are "nothing more than IOUs." That's because future benefits will have to come from "taxes that are being used today to pay for other government programs."(Source: Heritage Foundation, Misleading the Public)
Why Is There a Surplus?
The Social Security Act was signed into law by President Franklin D. Roosevelt on August 14, 1935. It created a program to pay an income to retired workers (65 or older). The funds for Social Security came from payroll taxes, known as FICA. The Social Security Trust Fund was established in 1937 to manage the income collected from these taxes so they could be redistributed as Social Security Income. Since then, the Trust Fund has collected $8.7 trillion, but only paid out $7.4 trillion in benefits. That's mainly because of America's demographics -- there's been more workers to pay the taxes than retired people to receive Social Security. It's also been because of tax hikes and adjustments to benefits. In 1977, the payroll tax rate was raised from 6.45% to 7.65%. As a result, the Trust Fund has held a surplus since then. (Source: Social Security History)The surplus is explained by demographics. Until recently, there's been 2.9 workers for every beneficiary. More money has gone into the fund via payroll taxes than has gone out as benefits. Thanks to those decades of surplus income, the Fund had $2.7 trillion in invested assets as of 2011. (Source: Table 2B1)
The Fund also receives interest income from its investments in "special issue" securities. The rate of return is determined by a formula enacted in 1960, and it changes each month. The average rate for each month in 2011 was 2.417%. However, the average rate for all Fund assets ($2.6 trillion) was higher, 4.401%, because the fund still holds bonds from past years when interest rates were higher.(Source: Social Security Administration, Fund FAQ)
Is Social Security in Danger of Running Out?
For years, the Board of Trustees warned that the demographic changes that created tyhe surplus would also lead to the Fund's demise. As the post-WWII Baby Boomers turn 65, leaving the workforce to retire, there will be fewer workers supporting more retirees. The financial crisis of 2008 has only hastened this trend. Higher unemployment means even lower payroll tax income.
In 2010, the Obama tax cuts, reduced the OASDI payroll taxes by 2%, while extending the Bush tax cuts. In fact, that was the first year that Social Security income was not enough to cover benefits. The fund only received $637 billion from payroll taxes, but paid out $702 billion in benefits. However, its other income, from investments and taxes on the benefits, more than covered its costs. Nevertheless, the fund took out $2 billion from the General Fund.
In 2011, the situation worsened. The Fund's total costs were $736.1 billion, including $725 directly paid in benefits. However, its income from taxes and investments was only $702.4 billion. The Fund required $102.1 billion from the General Fund, making it the first year the Fund contributed to the budget deficit. This will probably worsen for 2012, but get better in 2013. That's because the 2013 fiscal cliff deal ended the 2% payroll tax holiday. This will increase revenue to the Fund, and improve its cash flow shortfall. (Source: Social Security Administration, Operation of the Combined OASDI Fund, Table VI.A.3)
It won't help with the long-term demographic changes mentioned earlier. The Fund's $2.7 trillion in assets will be depleted by 2036. At that time, Social Security income from taxes will only cover 77% of projected benefits. Over the next 75 years, the Fund is projected to need additional revenue of $6.5 trillion to pay all scheduled benefits. (Source: SocialSecurityOnline, (Trust Fund FAQ)
What Can Be Done?
The Social Security shortfall could be wiped out by an additional 2.22% increase in payroll taxes. Different proposals are being developed to restore solvency. They require either a decrease in benefits paid, an increase in taxes or an increase in debt. Since the debt is already unsustainable, policy makers must choose between the remaining two, unpopular evils. As a result, no real changes to restore the solvency of the Social Security Trust Fund have been implemented.
A six-member Board of Trustees oversees the financial operations of the trust funds. The Board reports annually to the Congress on the financial and actuarial status of the trust funds. Article updated January 18, 2013