Millions of Future Social Security Recipients Could Face a Backdoor Benefit Cut

If you've been hearing rumors that Social Security is on the verge of bankruptcy, here's some good news: The program is not at risk of going broke. Social Security actually can't go broke because it's funded with payroll taxes.

But in the coming years, that revenue stream is expected to shrink as older workers retire. And thanks to declining birth rates, the number of replacement workers entering the labor force won't suffice in allowing Social Security to keep up with its financial obligations.

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According to the latest Social Security Trustees report, the program's Old-Age and Survivors Insurance (OASI) Trust Fund, which pays retirement and survivor benefits, is projected to run out of reserves in 2032. Once that happens, Social Security benefits could face a 22% cut.

Lawmakers have options to shore up the program's finances and prevent broad Social Security cuts, including raising payroll taxes, increasing the wage cap subject to Social Security taxes, and reducing benefits for higher earners.

One additional proposal that surfaces regularly is raising Social Security's full retirement age, the age at which claimants can collect their monthly benefits in full. But while it may help the program's finances, this change could effectively reduce the benefits many future retirees receive.

Why raising the full retirement age appeals to lawmakers

The Congressional Budget Office (CBO) has analyzed raising the full retirement age as one way to improve Social Security's long-term finances. Under one option, lawmakers could gradually raise the full retirement age beyond 67, where it currently stands for people born in 1960 or later.

Specifically, the CBO suggests increasing full retirement age by two months per birth year for workers born between 1964 and 1981. Full retirement age would eventually become 70 for anyone born in 1981 or later.

This doesn't mean that all Social Security recipients would be forced to wait until 70 to take benefits. As is the case today, it would still be possible to file as early as age 62. But the reduction in benefits for an early claim would be more severe.

The idea behind the proposal is relatively straightforward: Raising full retirement age could keep younger workers in the labor force longer, allowing Social Security to collect more payroll tax revenue. And because benefits would likely start later for many retirees, Social Security would pay out less over participants' lifetimes, helping to reduce the program's long-term costs.

But while it's easy to see why raising the full retirement age is an appealing, seemingly uncomplicated solution to Social Security's financial problems, it could seriously hurt future retirees.

The problem with raising the full retirement age

Although raising full retirement age could prevent broad Social Security cuts, it could also effectively function as a backdoor benefit cut. If full retirement age rises to 70 from 67, someone who waits until then would collect benefits for fewer years, on average, than someone who qualifies for Social Security under today's rules.

Furthermore, working until age 70 isn't equally feasible for all members of the labor force. Office-based professionals may be able to, but workers in physically demanding occupations may find it difficult or impossible to extend their careers.

At the same time, workers who are forced to retire early due to physical constraints risk permanently reducing their monthly Social Security checks, putting them at a huge disadvantage.

It's still up in the air

Raising full retirement age is just one of several proposals to prevent broad Social Security cuts. Congress has not approved such a change, and lawmakers could choose other solutions.

But with the OASI Trust Fund's depletion date rapidly approaching, some form of reform is needed soon. Today's younger workers should not automatically assume they'll have to wait longer to collect their Social Security benefits in full, but they should brace for that possibility just in case.

One thing younger workers should make a point of doing is building retirement savings, so they're less reliant on Social Security. That could help offset a potential self-induced benefit cut in case full retirement age is pushed back and waiting to file for Social Security isn't an option.

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