Payroll Taxes and the Future of Social Security

Ask the average millennial whether he or she expects to collect Social Security benefits at retirement, and you are likely to get a rather bleak sounding ‘no’ in response. According to Motley Fool, more than 80% of millennials do not have a very good outlook on Social Security. Whether right or wrong, much of what they believe about it is directly related to their ignorance about payroll taxes.

At BenefitMall, a Dallas-based provider of payroll processing and benefits administration services, payroll taxes are something they are intimately familiar with. They withhold and report payroll taxes on behalf of clients representing countless numbers of workers from coast-to-coast. And while BenefitMall staff understand where these taxes go, the average worker’s knowledge is limited, at best.

What Payroll Taxes Cover

Federal payroll taxes amount to 12.4% of a person’s weekly earnings. For employees on the payroll, that means equal shares being paid by both them and their employers; each pays 6.2%. Self-employed individuals pay the entire 12.4% themselves.

These taxes are represented as FICA on a worker’s pay stub. FICA includes both Social Security and Medicare contributions. The taxes paid by workers are used to cover the benefits paid to current Social Security and Medicare recipients.

This system of taxing workers to pay the benefits of retirees and the disabled is one of the reasons Social Security is not likely to ever go away completely. As long as there are able-bodied workers contributing to the system, those who benefit from it will have some income coming in.

The Coming Unfunded Liability

What millennials commonly mistake as a Social Security trust fund having no money left to pay them at retirement really has nothing to do with the trust fund itself, which may or may not be empty already. It is really about an unfunded liability as a result of benefits exceeding income.

It is expected that the Social Security system will begin paying out more than it collects by 2022. If Social Security does really have $3 trillion in assets in reserve, those assets are expected to be exhausted by 2034. That means a certain portion of Social Security benefits will be unfunded.

Some experts suggest that payroll taxes could fund up to 75% of the benefits being paid out. If that’s true, Social Security will still be underfunded by 2034. That means either a reduction in benefits, new taxes to make up the difference, or extending the retirement age so that fewer people are collecting at any given time.

Not Gone but Still Less

A proper analysis of Social Security indicates that the program will never be completely eliminated unless Congress acts to deliberately dismantle it. That is not likely to happen. So what millennials are really facing is not the fear of having no Social Security, but the fear of their benefits being less than what they expect.

It is quite likely that the value of the dollar will be greater 35 years from now. That being the case, every dollar that a millennial collects in Social Security benefits will have greater purchasing power in retirement. But if Social Security benefits have to be cut in real terms to make up for insufficient funding, those cuts will undoubtedly exceed any value the dollar gains. In the end, millennials are probably going to receive less from Social Security, in real terms, then their parents and grandparents.

Payroll taxes are part of the Social Security system. If more people understood how all this works, they might be more motivated to save for retirement apart from Social Security.