By James A. DeGaetano Jr., CPA, CFP

According to the Social Security Administration (SSA), almost 25% of all retirees rely on Social Security payments for over 90% of their income. In addition, over 50% rely on it for over half of their retirement income.¹ Discussion of the trust fund’s solvency is a timely topic. The question of why the Social Security program is not solvent long-term and how to solve it requires a cool head and a deep dive.  

The Social Security trust fund is accumulated via a payroll tax of 12.4% in total, with half paid by the employee and half by the employer. When it began in 1935, it was a 1% tax on the first $3,000 of income. Today, the tax is paid on the first $160,200 of earnings. For 23 million sole proprietorships in the United States – the most popular form of U.S. business entity – the business owner pays the full 12.4%. In other words, those choosing to live the American dream of being self-employed currently pay twice the percentage of payroll tax as an employee.  

When it comes to benefits, Social Security uses a Primary Insurance Amount (PIA) for the calculation. This is based on past average indexed monthly earnings (AIME) during a worker’s highest 35 years of employment history. Here is the formula for how benefits are calculated:  

• 90% of the first $1,115 of AIME, plus …
• 32% of the next $5,606 of AIME, plus …
• 15% of AIME more than $6,721.²

Social Security was initially not taxed, but now retired married couples earning over $44,000 per year (or singles earning over $34,000 per year) are taxed on 85% of their Social Security payments at their ordinary marginal tax rate. In other words, those that earn more prior to and during retirement tend to get less back as a percentage of what they funded into the system due to how their benefit is calculated and how they are taxed on it upon receipt.  

According to the SSA, retirees relying on this income tend to be unmarried, over 75, and have less than a high school diploma. Those who rely to a lesser extent are married, have college degrees, and are early in their retirement. Women rely on it more than men.³ While helpful to understand, these are irrelevant to the issue of Social Security’s solvency in the same way that a wage earner making $200,000 per year in his or her prime earning years is not paying his or her “fair share.”  

In 1942, there were 42 workers per retiree (42:1). Today the ratio is 3:1. In 2050, it will be 2:1 as the U.S. birth rate is expected to continue to decline. Since 1940, life expectancy among men and women has increased by about 12 years, and it continues to increase. Labor participation rates, too, have dropped significantly over the past 30 years. While it is evident that people across the globe desire to come to the United States, undocumented immigrants do not contribute payroll taxes because they are being paid in cash (also known as “under the table”).

According to the Congressional Budget Office, Social Security revenues in 2034 will need to be reduced by 23%, assuming no changes. This is when the trust fund runs dry. It does not mean that the system is bankrupt, but rather that incoming payroll taxes to cover the outgoing payments are not enough. This is an important distinction. Since it is a pay-as-you-go program, if there is not enough revenue coming in to cover the costs then the benefits must shrink if no changes are made.

The reality of Social Security is that those who put more into the system get less back as a percent contributed. It was designed that way: lower income earners receive back more as a percentage in retirement was intentional so that it could  help the wide base of lower income earners in the country as compared to higher earners.  

So, how do we solve the solvency conundrum? Most in the financial industry know that it could be solved on a napkin with a variety of strategies. The problem is solutions have become political weapons, with a lot of misinformation thrown into the mix about how the system works and the ways to solve it.  

As a compromise on this issue, here are a few ideas that, when taken together, can help.

First, take off the table any reduction in benefits to current retirees or those over 50. This relieves the accusations that any one party wants to reduce benefits for those receiving them now or reasonably expecting to in the next 15 years.  

Second, look at delaying Social Security in phases for those under the age of 50. People are living longer. The younger generations are buying homes, getting married, and having children later in life. It does not appear unreasonable to delay the time of receipt of Social Security.  

Third, increasing the payroll tax is a heavy burden on small business owners in our country. Considering the average net income of a sole proprietor is around $75,000 per year, and half do not survive past five years, increasing the payroll tax has a direct effect on this middle-class segment and an indirect effect on incentivizing the creation of new businesses to support the growth of our country. For these reasons, leaving out an increase on the payroll tax would be wise to gain momentum for a compromise. If it must be changed to pass politically, then the smallest increase possible is recommended, but the preference is to widen the labor participation rate instead of increasing the tax on those currently participating.  

Fourth, increasing the wage ceiling on the payroll tax is a different option and one that should be considered. However, a plan to have no ceiling would result in new compensation strategies by executives to avoid this altogether, thus missing the mark for the intended purpose. The economics of this are interesting. Let’s say the ceiling is bumped up to $250,000. A recent Bloomberg study noted one-third of Americans making over $250,000 live paycheck to paycheck due to rising inflation and household expenses.⁴ (They should hire a financial planner if that’s the case, but that is for another article.) The point is that definitions of “rich” or “very wealthy” vary based on perspective, and increasing the wage ceiling is a fine idea but will eventually have diminishing results.  

Fifth, since our economy is driven on consumption, and tax increases lead to a drop in consumption, let’s focus on how to increase the labor force in our country to increase the overall payroll tax. This is a much bigger discussion because it includes immigration policies to attract workers. According to NBC, the number of illegal border crossing in 2022 was over 2.7 million.⁵ This is greater than the population of Philadelphia, Baltimore, and Pittsburgh combined. Imagine a comprehensive plan to get these workers paying into the system.  

All parties giving a little will go a long way. Of course, this means that nobody will be completely satisfied. From my experience, this is what compromise looks like and it tends to result in a long-term solution with a higher probability of achieving its purpose.

For all of this to work, the tone at the top (and at the bottom) from both parties would benefit from an avoidance of targeted, campaign-style rhetoric meant to gin up votes out of fear rather than produce outcomes from a mutually beneficial resolution to continue Social Security for all Americans.  

We all work hard and have a mutual incentive to ensure this pay-as-you-go program is sustainable. Just maybe, the idea that fairness does not mean everyone gets the same but rather everyone gets what they need could be adopted by all involved in reaching consensus for settlement of the above ideas.  

¹ www.uvm.edu/~dguber/POLS21/articles/quick_facts_on_social_security.htm#:~:text=In%201940%2C%20there%20were%2042,at%20current%20payroll%20tax%20levels 
² 2023 Guide to Social Security (51st Edition)
³ www.ssa.gov/policy/docs/ssb/v77n2/v77n2p1.html 
⁴ www.bloomberg.com/news/articles/2022-06-01/a-third-of-americans-making-250-000-say-costs-eat-entire-salary
⁵ www.nbcnews.com/politics/immigration/migrant-border-crossings-fiscal-year-2022-topped-276-million-breaking-rcna53517 

James A. DeGaetano Jr., CPA, CFP, is president of Diamond Wealth Advisors and JD Media Company in Carlisle, Pa. He can be reached at thefruitfulretirement@gmail.com.

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