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June 22, 2014

Understanding our Social Security system

A number of surveys conducted over the last few years show that a growing number of Americans are losing faith that they will receive their full Social Security benefits as promised. Predictably, younger adults expect to receive no benefits at all when they retire. Although opinions differ regarding the urgency of the situation, most financial and policy experts agree there is good reason for concern about Social Security’s financial health.

The Social Security Act was signed into law in 1935 by President Franklin D. Roosevelt. It established two national social insurance programs; old-age retirement benefits for workers in private industry and unemployment benefits for those who had lost their jobs. In large part, these programs were a response to the devastating effects of the Depression that had decimated the lifetime savings and job opportunities for many older workers.

The scope of this program was broadened in subsequent years through amendments, including those adding benefits for disabled workers, dependents of retired and deceased workers and cost-of-living adjustments tied to the Consumer Price Index to offset the effects of inflation.

Social Security was designed to be a pay-as-you-go system, where the money raised by payroll taxes on workers is paid out to beneficiaries. Social Security benefits are funded primarily by the 12.4 percent (shared evenly by employer and employee) tax on our earnings from work. A portion of the payroll tax is used to pay current benefits, and the balance is invested in the Social Security Trust Fund, which consists of government bonds earning interest to help pay future benefits.

In prior years, there were more working people contributing to the system than retirees collecting benefits, generating cash flow surpluses for Social Security . However, as our population has aged, the ratio of retirees to workers has increased. People are also living longer in retirement, and the liability to pay more beneficiaries for longer periods is now being spread among a smaller number of workers presenting major challenges to the system.

Next week we’ll discuss the implications of the changing demographics to the Social Security system.

John Spoto is the founder of Sentry Financial Planning in Andover and Peabody. For more information, call 978-475-2533 or visit www.sentryfinancialplanning.com

This article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.

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