Last month, Social Security celebrated 84 years since being signed into law by Franklin D. Roosevelt. Since the first payout began on Jan. 1, 1940, and through today, it's become a vital source of income for retired workers, and subsequently the survivors of deceased workers and the long-term disabled.
According to statistics from the Social Security Board of Trustees, the program is set to pay out more than $1 trillion in benefits this year for the first time in its storied history. Further, data from the Social Security Administration finds that more than 3 out of 5 retired workers currently lean on the program for at least half of their income.
There's little doubt that elderly Americans would be in considerably worse shape if Social Security didn't exist.
However, this doesn't mean that Social Security has their back in every scenario. Although this program has proven vital to helping seniors make ends meet, it's failing retired workers in two specific ways.
Social Security's COLA isn't doing seniors any favors
Maybe the most blatant issue with Social Security has to do with the program's manner of accounting for cost-of-living adjustments, or COLA.
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has served as the inflationary tether for Social Security. The U.S. Bureau of Labor Statistics (BLS) reports a cumulative reading on the CPI-W each month that takes into account the price changes of a large predetermined basket of goods and services. If the price of goods and services rises, then beneficiaries should receive a raise commensurate with that increase the following year. At least, that's how it should work, on paper.
But there's a pretty glaring problem with the CPI-W, and you need look no further than its name to learn it. This is an inflationary index that tracks the spending habits of urban and clerical workers, many of whom aren't receiving a Social Security benefit and who are likely of working age. By comparison, more than 70% of Social Security recipients are senior citizens. Working-age Americans and seniors tend to spend their money very differently, and that's translated into inaccurate and insufficient COLAs being passed along to retired workers.
As an example, a BLS analysis of the experimental Consumer Price Index for the Elderly (CPI-E) and the CPI-W in December 2011 found that seniors spend twice as much of their monthly expenditures on medical care than urban and clerical workers. Housing expenses were also higher for seniors, relative to urban and clerical workers. Unfortunately, the CPI-W provides less weighting to these costs, and instead provides a higher weighting to categories like transportation, education, and apparel, which aren't nearly as important for retired workers.
According to an analysis from The Senior Citizens League, the purchasing power of a Social Security dollar has declined by 33% since 2000 for seniors as a direct result of the CPI-W failing to properly account for the inflation retired workers are facing.
The taxation of benefits has never been adjusted for inflation
While maybe not as egregious as Social Security's COLA issues, another pretty sizable problem can be traced to the taxation of benefits. Yes, Social Security may be taxable at the federal and state level -- the latter of which will depend on what state you live in.
In 1983, when the last major overhaul of Social Security was signed into law, one of the many changes made was to introduce a tax on benefits paid by higher-income retired individuals and couples. Any beneficiary whose modified adjusted gross income (MAGI) plus one-half of benefits paid exceeds $25,000 could have half of their benefits exposed to federal taxation. For couples filing jointly, federal taxation kicks in at $32,000, using the same formula.
Then, in 1993, the Clinton administration added a second tier, allowing up to 85% of benefits to be taxed at ordinary federal rates. Again using the same MAGI plus one-half of benefits formula, this higher tier kicks in at $34,000 for single beneficiaries and $44,000 for couples filing jointly.
The taxation of benefits was implemented as a means to boost revenue for the program as part of the bipartisan 1983 Amendments. Targeted to the well-to-do, it was only impacting around 1 in 10 senior households in 1983, and less than 1 in 5 by 1993, when the second tier was added. Today, however, nearly half of all senior households will owe tax on their Social Security benefits.
Why, you ask? Blame Congress for failing to adjust the income thresholds associated with the taxation of benefits. Despite being signed into law in 1983 and 1993, none of the income taxation thresholds for individuals or couples has ever been adjusted for inflation. Put into another context, this is no longer a tax that solely impacts the well-to-do. Middle-income seniors and retired couples are regularly becoming subjected to this tax over time, thereby reducing take-home income.
There are no easy fixes for these problems
Now for the real kick in the pants: There's no easy solution for either problem.
When it comes to Social Security's COLA, the truth is that neither political party likes the CPI-W and both want it replaced. The problem is that the respective replacements offered by Democrats and Republicans are on opposite ends of the spectrum. Democrats favor the aforementioned CPI-E, which would more accurately factor in the spending that retirees are contending with. Meanwhile, the GOP prefers the Chained CPI, which takes into account the idea of substitution bias. With neither party willing to concede an inch to the other, the CPI-W remains the default measure of inflation for Social Security, and in the process continues to drain purchasing power from senior citizens.
When it comes to the taxation of benefits, Congress is put between a rock and a hard place. On one hand, adjusting the limits for inflation, or eliminating the taxation of benefits entirely, would immediately put more money into the pockets of upper- and middle-income retired workers who are currently subjected to this tax. But it would also remove or reduce a vital source of income for the program at a time when Social Security is already staring down an estimated $13.9 trillion cash shortfall between 2035 and 2093. In essence, Congress needs every cent it can get to buoy Social Security, which throws the idea of adjusting these income thresholds for inflation out the window.
There's no denying how important Social Security has been for decades in providing a financial foundation for seniors. But let's not beat around the bush: It's also not doing retirees any favors in other respects.
The $16,728 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.