What Is the Social Security Trust Fund?

Image source: Getty Images.

Ensuring the financial viability of Social Security is a top priority for many Americans. The creation of the Social Security Trust Fund in the early 1980s correctly foresaw the need to set aside money to cover future liabilities under the program, and since its creation, the Trust Fund balance has grown steadily over time. With the baby boomer generation finally approaching retirement, however, that trend is expected to reverse itself, and the Trust Fund is expected to run out of money by the mid-2030s. In order to understand exactly what the concern is about using up all of the Trust Fund's assets, it's important to know the basics of the Trust Fund itself.

What the Social Security Trust Fund Is

The Social Security Trust Fund was part of the Social Security reforms enacted in the early 1980s in response to the recommendations of the National Commission on Social Security Reform, which has led by then-future Federal Reserve chair Alan Greenspan. Because of financial conditions in the late 1970s and early 1980s, Social Security faced the threat of benefit cuts if major changes weren't made. The creation of the Trust Fund was just part of an extensive set of revisions, which included the increase of the retirement age from 65 to 67, a rise in the payroll tax, and amendments to the way that certain benefits were calculated.

In particular, the idea behind the Social Security Trust Fund was to change fundamentally the philosophy behind the program. Until then, Social Security had been funded purely from payroll taxes on a pay-as-you-go basis, with the idea that taxes would roughly match up with the payouts for any given year.

With the Trust Funds, any excess payroll taxes collected in a given year were saved for potential use in future years. The Trust Fund's assets are invested in special Treasury bonds that pay interest and are redeemable upon request when Social Security needs money to pay out in benefits. Even now, the Trust Fund is still growing from year to year, largely because the sum of the payroll taxes Social Security collects and the interest earned on the Trust Fund's current assets add up to more than what the program has to pay out.

Will the Trust Fund last?

Over the past 30 years, the size of the Social Security Trust Fund has ballooned. From less than $50 billion in the mid-1980s, the Trust Fund currently has assets of almost $2.8 trillion.

Image source: Author with data from Social Security Administration.

That graph makes it seem as if the Trust Fund is in great shape. But the demands of an increasing number of retiring Baby Boomers will quickly make the Trust Fund balance start falling, with current estimates showing that happening around 2021. From there, the deficit annually will rise gradually, eating into the Trust Fund balance. Current estimates calculate 2034 to be the year in which the Trust Fund balance will reach zero.

The problem with the Trust Fund hitting zero is that it will potentially cause a disruption in benefits. Until the date at which the Trust Fund runs out of money, Social Security will use Trust Fund assets to cover the deficit between tax revenue and benefit payments. When that money is no longer available, Social Security expects that it will be able to pay only about three-quarters of the benefits it's supposed to pay under current law.

How to fix the Trust Fund problem

The looming exhaustion of the Social Security Trust Fund has policymakers looking at ways to avoid the cut in benefits that would result. In simplest terms, the program must either raise more revenue or reduce the benefits it pays in order to make itself more financially viable over the long haul. Numerous proposals include combinations of both methods, but none of them is entirely attractive to everyone involved.

The Social Security Trust Fund was a good idea in that it staved off the need to address what in the past had been immediate crises whenever annual Social Security funding was insufficient to pay benefits. With many lawmakers relying on the grace period that the Social Security Trust Fund provides, however, some might conclude that the false security that the Trust Fund created might prove to outweigh its benefits in the long run.

The article What Is the Social Security Trust Fund? originally appeared on Fool.com.

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