How It’s Financed

How It’s Financed

The financing of Social Security is a simple process. While you work, you pay taxes into Social Security and when you retire or become disabled, you (and your family members) collect monthly benefits from Social Security. Or when you die, your family may collect survivors benefits.

But there’s more to the financing of Social Security than taking in taxes and paying out benefits. This factsheet will explain what happens to your money between the time you pay Social Security taxes and the time you or your family members collect Social Security benefits.

The Taxes You Pay

Social Security taxes are used to pay for Social Security benefits. In addition, a portion of your taxes pays for part of your Medicare coverage. General tax revenues, not Social Security taxes, are used to finance Supplemental Security Income (SSI) payments. (SSI is a program administered by Social Security that pays benefits to people who have limited income and assets.)

If You Work For Someone Else

You and your employer pay taxes for Social Security and Medicare. You and your employer each pay 7.65 percent of your gross salary, up to a limit set by law. In 1998, the limit is $68,400. (This limit normally rises yearly based on increases in average wages.)

If You Work For Yourself

If you are self-employed, you pay 15.3 percent of your taxable income for Social Security and Medicare, up to the same limit of $68,400. However, there are special deductions you can take when you file your tax return to offset part of your tax rate.

Taxes For Medicare

If you make more than $68,400 in 1998, you continue to pay the Medicare portion of the Social Security tax on all of your earnings. The Medicare portion of the tax is 1.45 percent for employers and employees each, and 2.9 percent for self-employed people.

Where Your Taxes Go

The Social Security and Medicare taxes you pay are divided among several trust funds.

There are two Social Security trust funds:

  • the federal Old-Age and Survivors Insurance (OASI) trust fund is used to pay for retirement and survivors benefits; and
  • the federal Disability Insurance (DI) trust fund is used to pay benefits to people with disabilities and their families.

There also are two Medicare trust funds:

  • the federal Hospital Insurance (HI) trust fund is used to pay for the services covered under the hospital insurance (Part A)provisions of Medicare; and
  • the federal Supplementary Medical Insurance (SMI) trust fund is used to pay for services covered under the medical insurance (Part B) provisions of Medicare.

The 7.65 percent Social Security tax deduction is allocated in 1998 as follows:

  • 5.35 percent goes to the OASI trust fund;
  • .85 percent goes to the DI trust fund; and
  • 1.45 percent goes to the HI trust fund.

Note: Social Security taxes are not used to finance the SMI trust fund. Most SMI revenues come from the general fund of the Treasury. The remainder comes from premiums paid by enrollees.

How The Trust Funds Work

Every day, tax revenues are deposited in the trust funds. Social Security benefits are paid from these funds, and any money not needed to pay benefits is invested daily in U.S. government bonds.

The trust funds are governed by a Board of Trustees. Members are the Secretary of the Treasury, Secretary of Labor, Secretary of Health and Human Services, the Commissioner of Social Security and two public trustees who serve four-year terms.

The Board of Trustees is required by law to report annually to the Congress on the financial condition of the funds and on estimated future operations.

At times in the past, Social Security was financed on a current-cost basis, popularly known as "pay-as-you-go." Some have compared that method to a pipeline, with taxes from workers flowing into one end of the pipe and payments for beneficiaries flowing out the other end.

Since 1983, the program has operated under a "partial reserve" method of funding. The intent is to have the system take in more than it pays out in order to build up the large reserve funds needed to help pay for the benefits of an increasing number of retired workers.

What Happens To The Reserve Funds

Any Social Security reserves that are not used for payment of benefits or operational expenses (which are consistently less than 1 percent of revenues) are invested only in U.S. government securities–generally considered the safest of all investments–and earn the prevailing rate of interest. These are normally special obligations issued specifically for the trust funds. The amount of interest earned is substantial. For example, in 1997, the Social Security trust funds earned $43.8 billion in interest, representing an effective annual interest rate of 7.5 percent.

Trust Fund Forecasts

The latest report from the Board of Trustees, released in April 1998, provides mixed news about the future financial condition of Social Security.

The combined OASI and DI trust funds will be able to pay benefits for many years into the future. In the long range, however, the funds are not adequately financed and would become exhausted in 34 years, based on the most likely assumptions in the 1998 trustees report.

HI Trust Fund

The Board reports that the Hospital Insurance trust fund will be able to pay benefits for only about 10 years. Rising health care costs and a declining ratio of taxpayers to Medicare recipients combine to place the trust fund "severely out of financial balance" in the long range.

In their report, the trustees recognized recent legislation to help control future HI program costs and urged further congressional action.

Are Social Security Taxes Used For Other Purposes?

A persistent, but false, rumor is that trust fund money has been used for purposes other than Social Security payments or operational expenses.

There is confusion over this issue because of the trust fund investment procedures. When you buy Treasury bonds, you are, in effect, lending money to the government to use for various federal programs and projects. The same is true for the investments Social Security makes in government bonds. The government uses the money it has borrowed from Social Security for other purposes. But just as the government pays you back with interest when you redeem your bonds, it always makes good on its obligations to Social Security, paying the trust funds back with interest.

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