Cutting Social Security Benefits Isn't As Bad An Idea As It Sounds

This month, nearly 63 million people, many of them senior citizens, will receive a Social Security benefit. According to the Social Security Administration, just over 3 out of 5 retired workers relies on this guaranteed monthly payout to account for at least half of their income. Put another way, the elderly poverty rate would likely spike higher without the financial foundation provided by Social Security.

This article originally appeared in the Motley Fool.

Social Security's $13.2 trillion problem

However, America's most important social program is facing what could arguably be deemed as its greatest hurdle since inception in 1935, at least according to the latest annual Trustees report.

Released in early June, the Trustees report projects that the program will undergo a change in 2018 that we haven't witnessed in 36 years. Namely, Social Security will expend more than it collects in revenue. Though we're only talking about a $1.7 billion net cash outflow, which is peanuts compared to the $2.89 trillion the program has in asset reserves, this annual outflow is expected to grow rapidly in size in 2020 and beyond. Should expenditures continue to greatly outpace revenue, Social Security's $2.89 trillion in excess cash could be gone by 2034.

What does this mean, exactly? The good news is it doesn't mean the end for Social Security. The program's two recurring sources of income -- the 12.4% payroll tax on earned income, and the taxation of benefits -- would remain intact and provide funds for disbursement to eligible beneficiaries. The bad news is that it signals a potential cut to benefits of up to 21% by 2034.

The Trustees report went on to forecast that a $13.2 trillion cash shortfall exists between 2034 and 2092. The only way to fix this mess is by raising revenue, cutting expenditures, or implementing some combination of the two.

Generally speaking, practically no solution is less popular among the public than cutting Social Security benefits. As noted, a majority of today's retirees are reliant on the program for a majority of their income. Cutting benefits could therefore put these retired workers at risk of being unable to meet their payment obligations in retirement.

Cutting Social Security benefits is a better idea than you probably realize

Yet, as crazy as this might sound, cutting Social Security benefits isn't that bad of an idea. If done the right way, benefit reductions could be a positive for the program in more ways than one.

Now, to be clear, when talking about "cutting benefits," I'm not describing a scenario where the federal government takes its proverbial scissors and simply lops off a percentage of what current retirees are due each month, as described in the Trustees report. Rather, these reductions would be passed along in the form of a gradually increased full retirement age.

Your full retirement age is the age at which you become eligible to receive your full retirement benefit, as determined by your birth year. It's set to peak at age 67 for workers born in 1960 or later. By gradually raising the full retirement benefit to age 70, as an example, it would protect existing retirees from any chance of a benefit reduction, but require future generations of workers to make a choice. Either they would have to wait longer to receive their full monthly payout, or they'd claim early and take a steeper reduction to their monthly benefit. Regardless of what they choose, lifetime benefits paid by the program would fall over time, relative to the current payout schedule with a full retirement age that peaks at 67. These savings may be enough to completely bridge the estimated $13.2 trillion cash shortfall through 2092.

Three reasons cutting benefits makes sense

You're probably asking yourself, "How is this a good thing?"

For starters, it factors in the adverse impact longevity has had on the program since inception. Between 1935 and 2022, the full retirement age will have increased just two years. Meanwhile, average life expectancies are up nine years since 1960, with more Americans than ever reaching the eligible Social Security claiming age. Raising the full retirement age would reduce the amount of time that retirees are leaning on the program, more closely aligning the program with how it was designed in 1935.

Secondly, it would protect existing retirees from any chance of a benefit cut. By adjusting the full retirement age, only workers who are presumably a decade or longer away from being eligible for Social Security would be impacted.

And finally, since Social Security is only designed to replace 40% of the average worker's wages in retirement, a cut to lifetime benefits should coerce Generation X, millennials, and Generation Z to save more of their income and invest for their future, thereby making themselves less dependent on the program. Personal saving rates in the U.S. are anemic, so anything that would encourage better saving and investing habits would be a good thing.

But, as I've stated previously, no Social Security solution makes more sense over the long run than a bipartisan fix. In addition to raising the full retirement age, which is a solution regularly proposed by Republicans, adjustments should be made to the maximum taxable earnings cap, a proposal by Democrats, to raise revenue. This combination of solutions would tackle the root problems of Social Security much better than a one-party fix.

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