Why 5 Million Americans Are Missing Out on Social Security

Since 1935, Social Security has provided a safety net for retirees. Granted, that safety net isn’t a complete one. The federal program was intended to meet around 40% of financial needs in retirement.

Still, most Americans count on Social Security checks to kick in when they retire, whether it’s at age 62, 70, or somewhere in between. But not everyone is included. Here’s why roughly 5 million Americans are missing out on Social Security.

Image source: Getty Images.

Who’s excluded?

To pass the Social Security Act of 1935, legislators had to navigate past a constitutional dilemma. There were questions about whether or not the federal government could impose payroll taxes on state and local government employees who were already covered under retirement pension plans.

This was problematic because payroll taxes served as the primary funding source for the Social Security program. The U.S. Congress took the easy way out: It allowed state and local governments to exclude workers from Social Security altogether. As a result, around 5 million people today work in jobs that aren’t covered by Social Security.

There were some caveats, though. The state and local plans couldn’t make employees work longer than Social Security’s full retirement age to begin receiving benefits. Federal law required the plans to provide an annual benefit for life that at least matches the annual primary insurance amount (PIA) individuals would have received if they were Social Security beneficiaries.

But determining whether or not the state and local pension plans really provide comparable benefits to Social Security isn’t as straightforward as it might seem. To help meet this challenge, the federal government developed Safe Harbor benefit adequacy guidelines. These guidelines provide a formula that pension plans can use to ensure workers’ benefits are in line with what they would receive if they participated in Social Security.

Still missing out?

With all of that as background, you might think that the 5 million Americans really aren’t missing out. After all, their retirement plans must be just as good as Social Security, right? Not so fast.

A study funded by the Social Security Administration (SSA) analyzed 66 state and local government pension plans. It found many of these plans aren’t as generous for employees who have been hired recently. The study determined that “a significant minority of them are likely to fall short of providing Social Security-equivalent benefits.”

The problem primarily impacts individuals who work with state and local governments that offer other pension plans early in their career and later move to a job that’s covered by Social Security. Between 750,000 and 1 million workers per year could be at risk of receiving lower retirement benefits than Social Security provides, according to the study.

There are other potential issues for workers in these pension plans as well. The plans don’t always provide cost-of-living adjustments (COLAs) as large as Social Security gives. Many of the plans also don’t have enough assets to cover their liabilities after two stock market downturns and periods of insufficient contributions.

A safety net with some big holes

Remember that Social Security was designed to provide a safety net for retirees. The goal of the program was to ensure a minimum level of retirement income for every American. Congress’ workaround in 1935 for state and local government employees intended to allow those workers to keep their pension plans as long as they provided at least the same benefits as Social Security did.

The SSA-sponsored study shows that millions of Americans, over time, could not only miss out on Social Security but also miss out on the minimum level of benefits that the federal program would have provided to them. For these individuals, their retirement safety net could have some big holes.

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