In February, Congress reached an 11th-hour agreement to extend the 2% Social Security payroll tax reduction through the end of the year.
Like most matters related to taxes and Social Security, the decision generated significant debate, given the competing outcomes: more take-home pay for working Americans versus greater risk to the system and the income of future retirees.
The issue resurfaced in late April with the release of the 2012 annual report of the Trustees of Social Security and Medicare, which projected a significant decline in the financial status of the Social Security program.
Although a bipartisan agreement to let the tax cut expire may be reached, a further extension into next year still hasn't been entirely ruled out.
A pure actuarial look at the payroll tax issue sheds light on how the average person might want to view the payroll tax holiday — at least what may be left of it — in terms of the federal budget, the relative safety of Social Security assets and the ultimate impact that this can have on their long-term financial security. Simply put, the extra income that a taxpayer has been enjoying this year (e.g., $1,000 for an individual earning $50,000 annually) may be best “spent” as savings into a 401(k), individual retirement account or other retirement vehicle.
Although the Social Security liability is “off budget” under federal accounting rules (akin to the “off balance sheet” concept for corporations), the assets in the Social Security trust funds essentially are U.S. Treasury obligations. Thus the debts the government owes to Social Security are really part of the national debt.
With that in mind, there are real doubts about whether the assets backing Social Security — one leg of the traditional three-legged retirement stool, which also includes pensions and personal savings — are real, given the burgeoning U.S. budget deficit.
One school of thought is that Social Security assets are backed by the full faith and credit of the U.S. government. Because the government has never defaulted on its debt and isn't expected to in the future (at least not in the next 30 years, as evidenced by historically low yield levels and the steady flight to Treasuries), Social Security assets should be regarded as bona fide tangible and relatively safe obligations.
MORE PRESSING PROGRAMS
However, from a federal accounting perspective, even though Social Security is off budget, it is still a part of the U.S. government's overall operations. As such, until existing assets are exhausted, this money could be diverted, by way of Social Security payroll tax reductions, to fund other, more pressing programs, including direct consumer stimulus spending.
Viewed this way, the status of the trust fund obligations becomes a bit more nebulous.
Given these distinct but equally rational views, it is no surprise that many individuals are concerned about Social Security and what will be left of the program when it is their turn to retire. This also underscores the point that average working Americans must prepare for the uncertain future of Social Security by assuming more responsibility for their own planning and saving.
So what does all this fiscal analysis mean?
IN THE RED
The alarming truth is that Social Security is already in a marginal deficit position today. In 2010-11, benefits and expenses eclipsed payroll tax income for the first time since 1983.
In light of this budget reality, federal insurance reports have noted that either a permanent 2.7% increase to payroll taxes (up from 2.2% last year) or an immediate 16% reduction to all current and future benefits (up from 14% last year) or some combination thereof, including extending the retirement age, will be required to restore fiscal balance.
Bottom line: The nearly 160 million workers who are benefiting from the reduced payroll tax rate this year and hoping for another extension in 2013 should understand that the government is in effect fronting tomorrow's Social Security benefits by cutting payroll taxes today. In this context, it might be prudent for all of us to take advantage of our current benefit by applying the money toward our savings or reducing our debt.
Mark Kaye is chief financial officer of ING U.S. Retirement, which provides retirement plans, products and services.