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Social Security: something's gotta give
Social Security reform will involve sacrifice, with or without individual investment accounts.
February 17, 2005: 9:36 AM EST
By Jeanne Sahadi, CNN/Money senior writer
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NEW YORK (CNN/Money) – Amid the rancorous debates over adding individual investment accounts to Social Security, a basic fact is often overshadowed.

Accounts or no, to make the system solvent long-term, you'll either end up paying more for the benefits promised or you'll receive less of them, or, possibly, both.

That is, something's gotta give if the system is to meet the needs of future retirees based on the number of workers there will be to support them.

With any proposal for Social Security reform, expect to see measures that reduce the promised benefit payout, either directly or indirectly.

Here are some of the options that may be considered:

Change the formula for starting benefits: Starting benefits might be reduced if the formula by which they're calculated is changed.

One frequently discussed option: Instead of linking -- or indexing, as it is known -- initial Social Security benefits to wage growth, the starting benefits would be indexed to inflation. Since inflation tends to rise less quickly than wages, it's a reduced measure by which to set starting benefits.

Provide incentives to work longer: Currently, retirement benefits are calculated based on your 35 highest earning years. That formula may be changed to cover the 40 highest earning years.

According to the American Academy of Actuaries, doing so would reduce benefits an average of 3 percent.

In general, the shorter your work history, the less advantageous such a change would be. That's because your average earnings over a 35-year period would be higher than if they're measured over a 40-year period.

Reduce cost-of-living adjustments: Currently, recipients' benefits are increased every year by a cost of living adjustment (COLA). Under reform, the COLA may be measured differently and adjusted downward.

So, for instance, in 2005, retirees received a 2.7 percent bump in their benefits. A retiree receiving a $1,000 monthly benefit in 2004 would have seen an increase in monthly payments of $27. But if the COLA was reduced by, say, half a percentage point, to 2.2 percent, the increase would be $22.

Raise the cap on wages subject to the payroll tax: Currently, you and your employer each pay 6.2 percent of your wages into Social Security on the first $90,000 of your wages. Lawmakers may choose to raise that cap or eliminate it entirely.

Say they raise the cap to $200,000. Earners at that level or above would pay nearly $7,000 more into the system than they do now. At the $90,000 level, they'd pay in $5,580. At the $200,000 level, they'd pay in $12,400.

Raise the payroll tax rate: Instead of the12.4 percent of your wages -- half paid by you, half by your employer -- that goes into Social Security now, Congress could increase that by, say, 1 percentage point. That means you and your employer would each pay in 6.7 percent. So if you make $75,000, you'd pay an additional $375 a year in Social Security tax. The president has said he is opposed to this option.

President Bush has said repeatedly this is the one option he would not consider.

Raise the retirement age: Congress may choose to increase the retirement age to, say, 70 by a certain year. So if you're going to retire in that year, and you're currently scheduled to be eligible for full retirement benefits at 67, you would be paying the same amount into the system, but receive three years' fewer benefits.

Reduce benefits for future retirees: Lawmakers could opt for an across-the-board reduction of promised benefits – say, by 5 percent – for all but current retirees. So, for example, if you're currently promised a benefit of $1,500 a month, you'd get a benefit of $1,425 instead.

Tax more of your Social Security benefits in retirement: Right now, a portion of your Social Security benefits are taxed as income if your total income exceeds certain thresholds. For example, if you're married and your income exceeds $32.000, you pay tax on 50 percent of your benefits. If it exceeds $54,000, you pay tax on 85 percent of them.

One reform measure might be to eliminate those thresholds so that 85 percent of all benefits would be taxable. Low-income retirees probably would not feel the effect, however, since they would qualify for deductions and exemptions that would negate the tax.

And since 85 percent of higher income people's benefits are already subject to income tax, "this will fall mainly on the middle-income area," said Ron Gebhardtsbauer, senior pension fellow at the American Academy of Actuaries.  Top of page

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