Can a Stock Market Crash Hurt Social Security?

Since the end of the Great Recession, the stock market has handsomely rewarded patient investors. But over the past two months, volatility has picked up in a big way. Both the benchmark S&P 500 and growth stock-driven Nasdaq Composite have endured their biggest percentage declines in nearly two years.

With the pandemic-induced crash of February-March 2020 still fresh in investors’ minds, the prospect of a full-fledged stock market crash is, once again, creeping into the realm of possibilities.

While crashes and steep corrections can temporarily impact the tens of millions of people putting their money to work in the market, you might be wondering how or if these wild swings in equities have consequences beyond Wall Street.

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For example, America’s most successful social program, Social Security, divvies out a payment to more than 65 million beneficiaries each month, over 72% of which are retired workers. If the stock market were to crash again, would it hurt the Social Security program?

The answer is a bit more complex than you might think.

Social Security’s funding sources aren’t generally impacted by a stock market crash

If examined in the direct sense of “do stock market crashes hurt Social Security?” the answer is no. The reason there’s no direct pain felt on the program is because of the way it’s funded.

In 2020, Social Security collected about $1.12 trillion in revenue, with this income generated from three sources:

Payroll tax contributions: $1 trillion
Taxation of benefits: $40.7 billion
Net interest income: $76.1 billion

As you can see, the 12.4% payroll tax on earned income (up $147,000 in 2022) generates the lion’s share of revenue for the program. By earned income, I’m referring to salary and wages. Investment income isn’t hit with the payroll tax. Regardless of whether payroll tax contributions are being paid 50/50 by employers and employees or 100% by the self-employed, a stock market crash doesn’t weigh down how much payroll tax revenue Social Security brings in.

Likewise, taxing Social Security benefits, once the recipient of those benefits crosses above a certain income threshold, won’t be impacted by fluctuations in the stock market.

The third method used to generate revenue for Social Security is the interest income the program nets from the special-issue bonds it holds. The program had close to $2.88 trillion in net asset reserves (i.e., excess cash) at the end of 2021, which is required by law to be invested in special-issue bonds, such as U.S. Treasuries. The interest earned on these bonds provided $76.1 billion in income in 2020.

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However, there’s the potential for an indirect effect

Although Social Security isn’t directly impacted by heightened periods of volatility in the stock market, there can be an indirect effect.

While the Federal Reserve is primarily tasked with overseeing monetary policy and its subtle changes over time, it occasionally does step in to put out emotion-driven fires on Wall Street. For example, the Fed has, on multiple occasions over the past 14 years, initiated quantitative easing (QE) measures designed to lower lending rates and improve consumer/business confidence in the U.S. economy. These periods of QE have involved buying mortgage-backed securities and/or long-term U.S. Treasury bonds.

If the Fed is trying to ease investors’ anxiety during a stock market crash and it either undertakes QE measures or lowers interest rates, this can lower the yield Social Security receives on future special-issue bond purchases.

But understand there are two key limitations here. First, Social Security only brought in 6.8% of its revenue from interest income in 2020. Even if bond yields were to tick lower as a result of the Fed’s monetary policy actions, the negative impact on Social Security’s aggregate annual revenue would be quite small.

The other limitation is that the federal funds target rate is already at a historic low of 0% to 0.25%. The nation’s central bank has made it clear that it has no intention of reducing this target rate, which dictates where interest rates head, into negative territory. In other words, the Fed really doesn’t have the ability to push special-issue bond yields any lower at the moment, even if the stock market were to crash.

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Here’s what’s really hurting Social Security

Now that you have a better understanding of how stock market crashes can, in certain scenarios, indirectly impact Social Security in a negative way, let’s take a brief look at the direct reasons the program is expected to struggle moving forward.

Virtually all of Social Security’s shortcomings are tied to ongoing demographic shifts. One of the best-known of these shifts is the retirement of baby boomers. There simply aren’t enough new workers entering the labor force to counter the millions of boomers hanging up their gloves and work coats each year. This shift continues to weigh down the worker-to-beneficiary ratio.

A lesser-known issue that builds on the decline in the worker-to-beneficiary ratio is historically low birthrates in the United States. Though the pandemic has certainly had a negative impact, birthrates have been declining in the U.S. for more than a decade. Couples are waiting longer to get married, choosing to wait longer to have children, and are less confident about bringing a child into the world from a financial perspective.

As birthrates plunge, longevity has increased. Living longer is fantastic in the respect that we get to spend more time with the family and friends we love. However, Social Security was never designed to pay retirees a monthly benefit for two or more decades. As longevity rises, so does the strain on Social Security.

Another issue with the worker-to-beneficiary ratio can be found with immigration. The Social Security program relies on a steady stream of net legal immigration each year. Since immigrants tend to be younger, they’ll spend decades in the labor force contributing to the program via the payroll tax. But with net legal immigration declining half of what it was in the mid-1990s, the worker-to-beneficiary ratio has taken a hit.

The only Social Security shortcoming that isn’t based on a demographic shift is Congress’s inability to strengthen the program. Even though both major political parties recognize flaws in the program, neither has been willing to find a middle ground with their opposition on a fix.

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