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How Does Social Security Work?

Today's workers pay for today's Social Security benefits recipients

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Mature couple doing paperwork using laptop
Andersen Ross/Digital Vision/Getty Images
Although many people believe that the Social Security taxes they pay are held in interest-bearing accounts and earmarked for their own retirement, in reality Social Security is a pay-as-you-go retirement system.

Today's Workers Fund Today's Retirees
In other words, the Social Security taxes paid by today's workers and their employers are used to pay the benefits for people who are currently retired, and for other beneficiaries such as workers who become disabled or the families of workers who die.

How Many Workers Cover Current Social Security Beneficiaries?
It's interesting to see how the ratio of Social Security-paying workers has changed compared to the number of people who receive Social Security benefits, according to the Social Security Administration's table of Social Security workers vs. beneficiaries.

Here are a few highlights:
  • As of 2006 (the latest year for which data is available), there are 3.3 workers paying into Social Security for every person who receives benefits, for a ratio of 3.3 to 1.
  • By 2030, that ratio will be 2 to 1. Part of the reason for the steep decline is that the oldest of the 79 million baby boomers will begin retiring in 2008. At the same time, birth rates are declining.

Contrast this with the ratio of Social Security workers vs. beneficiaries in 1940, when the program began: 159.4 to 1, and it's easy to see why Social Security has a troubled financial future.

Social Security Money Held in Trust Funds
For now, Social Security is still taking in more money than it pays out in benefits. Any money that's left over goes into the Social Security Trust Funds.

  • Currently, the Trust Funds have large reserves, but by 2018 those surpluses will start turning into deficits.
  • The benefits owed will be more than the taxes collected, and unless the program is changed, Social Security will have to dip into the Trust Funds to pay benefits.

In about 30 years, there will be nearly twice as many older Americans as there are today. Those changing demographics put Social Security benefits in jeopardy.

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