Social Security's Uninvested Funds: Why And What If?

Social Security trust funds are accounts managed by the US Treasury. They take in payroll taxes from workers and their employers and pay out benefits to Social Security recipients. They invest any surplus in special-issue US government debt securities. These securities can be redeemed at face value at any time to pay fund obligations. In 2021, Social Security costs exceeded total income for the first time. A 2024 analysis revealed that the trusts are expected to be able to pay full benefits only until 2035.

There have been discussions about whether the money should be invested in equities, which would theoretically provide a higher rate of return and require less in tax increases or benefit cuts to achieve long-term solvency. However, critics argue that equity investment could interfere with private markets and that there may not be enough funds to invest in stocks while also paying out benefits.

Social Security trust funds are projected to run out by 2034, with benefit cuts of 20% or more

The Social Security trust funds are projected to run out by 2034, with benefit cuts of 20% or more. This projection is based on the assumption that the funds will continue to be invested in special-issue U.S. government securities, which are considered low-risk investments. However, there have been discussions about investing a portion of the Social Security trust funds in equities to potentially achieve higher returns. While this approach has its advantages, there are also concerns about the risks involved and the potential impact on private markets.

The Social Security trust funds are managed by the U.S. Treasury and consist of two separate funds: the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund. These funds receive payroll taxes from workers and their employers and use the money to pay out benefits to Social Security recipients. Any surplus funds are currently invested in special U.S. government debt securities, which can be redeemed at face value to meet fund obligations.

In recent years, the Social Security program's costs have exceeded total income, including interest. As a result, the trust funds' reserves are projected to run out by 2034, leading to a situation where only a portion of the scheduled benefits can be paid. This projection assumes that no changes are made to the current investment strategy.

One alternative that has been proposed is to invest a portion of the Social Security trust funds in equities, such as stocks or other financial instruments. This approach has the potential to generate higher returns compared to the current investment strategy, which could help reduce the need for tax hikes or benefit cuts. However, there are also several concerns and risks associated with this approach.

Firstly, investing in equities could interfere with private markets and create the perception that trading bonds for stocks is a simple way to generate wealth. Additionally, equity investments typically involve greater risk, and there is no guarantee that they will always provide higher returns. Secondly, the current discussion around investing in equities may be moot, as the Social Security trust fund is rapidly heading towards depletion, and there is a low likelihood of raising taxes to rebuild it.

In conclusion, while investing in equities could potentially increase returns for the Social Security trust funds, there are valid concerns about the risks and potential impact on private markets. With the trust funds projected to run out by 2034, benefit cuts or tax increases may become necessary to ensure the continued payment of benefits to recipients.

The funds are invested in US treasury securities, which can be redeemed at face value at any time

The Social Security trust funds are accounts managed by the US Department of the Treasury. They are invested in US treasury securities, which can be redeemed at face value at any time to pay fund obligations. These securities are issued expressly for use by the trust funds and are not available to the public.

The two types of securities held by the trust funds are "special issues" and "public issues". The former are securities available only to the trust funds, while the latter are available to the public (marketable securities). The trust funds now hold only special issues, but they have held public issues in the past.

The interest rate on the special issues is set by a formula established in 1960 through amendments to the Social Security Act. For special issue debt issued to the trust funds in a given month, the interest rate is the average market yield on the last day of the prior month for marketable US government debt securities not due or callable for more than four years, rounded to the nearest one-eighth of a percentage point.

In 2023, the trust funds earned an effective interest rate of 2.4%, while the average of the 12 monthly rates for the debt they purchased that year was 4.1%. In May 2024, the interest rate for new special issue debt bought by the Social Security trust funds was 4.750%.

The special government securities come in two types: short-term certificates of indebtedness, which mature on the following 30 June, and bonds with a term of one to 15 years. The short-term certificates and bonds issued to the Social Security trust funds are not traded in the bond market or available to the public. Like other Treasury securities, however, they are backed by the full faith and credit of the US government.

Critics fear equity investment could interfere with private markets

Critics of investing social security funds in equities fear that it could interfere with private markets. They worry that social security equity investment would have adverse effects on the stock market and corporate decision-making.

One concern is that the federal government would be investing money, which could lead to political influence. Additionally, any investments would incur management fees and would compete with private wealth managers and investors. The reduction in general revenues resulting from the redirection of social security funds would require increased taxation or borrowing, which would largely offset any macroeconomic benefit.

Another concern is that trading bonds for stocks could create the impression that the government can get rich simply by issuing bonds and buying equities, or that this would be a way to create "magic money".

Some critics also argue that the time for investing social security funds in equities may have passed, as the social security trust fund is rapidly heading towards zero, and rebuilding the fund may not be wise or feasible.

The US Social Security system is pay-as-you-go, not a sovereign wealth fund

The US Social Security system is a pay-as-you-go system, not a sovereign wealth fund. This means that the government takes in money in the form of taxes and spends it in the form of benefits. Currently, Social Security is running a surplus, but this is not a requirement. In the future, it may run a deficit, in which case Congress could allocate additional funds to pay the same amount of benefits.

If Social Security runs a surplus, that money is invested in US treasuries and used to offset other debts or taxes. The surplus is not required, and the system can function with a deficit.

If the funds were invested in the stock market instead of US treasuries, this would lead to several distortions. Firstly, the federal government investing money could lead to political influence. Secondly, any investments would incur management fees and compete with private wealth managers and investors. Thirdly, the reduction in general revenues resulting from the redirection of Social Security funds would require increased taxation or borrowing, which would largely offset any macroeconomic benefit.

The US Social Security system is not a sovereign wealth fund, and it is unlikely that it will become one. Most sovereign wealth funds are created when a country projects that its national income will be greater now than in the future due to a depleting national resource or a youth dividend. This does not apply to the US, as oil revenues do not dominate the economy, and the US is not ageing particularly quickly relative to the rest of the world.

Investing in the stock market would require a tax increase to fund current costs and provide additional funds

Furthermore, investing Social Security funds in the stock market does not increase the net wealth or productive capacity of the US economy. The ability to pay Social Security benefits depends primarily on the size of the US economy, demographic changes, and benefits/liabilities. Investing these funds outside of the US could lead to marginal changes at best.

Additionally, the Social Security trust fund is rapidly heading towards zero, and the likelihood of raising taxes to rebuild it is low. Borrowing to invest in the stock market would require the government to repay the borrowed funds with interest, making it an unwise and unfeasible option.

Therefore, while investing in the stock market may seem appealing, it is not a prudent decision due to the potential risks and negative consequences.

Frequently asked questions