Social Security: Trust Fund Investment Practices
Released: 2014-08-20T00:00:00

Background

Social Security is financed primarily by payroll and self-employment taxes, as well as by a portion of the proceeds from the income taxation of Social Security benefits. The revenues are deposited in the U.S. Treasury. Social Security benefits and administrative expenses are also paid from the U.S. Treasury. By law, if Social Security revenues exceed expenditures, the "surplus" is credited to the Social Security trust funds in the form of U.S. government securities. The money itself, however, is used to pay for whatever other expenses the government may have at the time. There is no separate pool of money set aside for Social Security purposes. That is not to say that the trust funds are ephemeral—as long as the trust funds show a positive balance, they represent the authority and an obligation for the U.S. Treasury to issue benefit payments during periods when the program's expenditures exceed revenues. At the end of calendar year 2013, the trust funds were credited with holdings of $2.8 trillion. Section 201 of the Social Security Act provides the following guidelines for trust fund investment.

1. Funds not immediately in demand for benefits or administrative expenses are to be invested in interest-bearing obligations guaranteed as to both principal and interest by the United States. 2. Obligations are to be purchased at issue at the issue price or at the market price for outstanding obligations. 3. The Managing Trustee of the Social Security trust funds (the Secretary of the Treasury) is required to invest in special "nonmarketable" federal public-debt obligations—special issues to the trust funds that are not available to the general public—except where he or she determines that the purchase of marketable federal securities is "in the public interest." 4. Special issues shall have maturities fixed with due regard for the needs of the trust funds and will pay a rate of interest, calculated at the time of issue, equal to the average market yield on all marketable interest-bearing obligations of the United States that are not due or callable (redeemable) for at least four years. 5. Marketable federal securities purchased by the trust funds may be sold at the market price and special issue obligations may be redeemed at par plus accrued interest (without penalty for redemption before maturity).

The Treasury Department has determined that the purchase of marketable federal securities (i.e., public issues) would be in the public interest only when it might serve to stabilize the market for Treasury issues. Because an "unstable market" would be characterized by falling bond prices, purchases of marketable federal securities at these times would appear to be advantageous for the trust funds. In practice, however, open market purchases have been rare. Although the trust funds have held public issues in the past, the trust funds currently hold special issues only.

The interest earned on these holdings is credited to the trust funds semiannually (on June 30 and December 31); it is done by issuing additional federal securities to the trust funds. In calendar year 2013, net interest totaled $102.8 billion, representing 12% of total trust fund income. The effective annual rate of interest earned on all obligations held by the trust funds in calendar year 2013 was 3.8%. The interest rate earned on special issues purchased by the trust funds in August 2014 is 2.375%.

The maturity dates of newly issued special issues are set by a standardized procedure. Revenues are invested immediately in short-term issues called certificates of indebtedness, which mature on the next June 30. On June 30 of each year, certificates of indebtedness that have not been redeemed are reinvested in longer-term special issue bonds. Generally, the maturities of these bonds range from 1 to 15 years; the goal is to have about one-fifteenth of them mature each year, depending on the needs of the trust funds.

Issues

While some critics have questioned whether the current investment policy has constrained the earnings of the trust funds, over the years various advisory councils, congressional committees, and other groups generally have endorsed it. It has been justified as a way to ensure safety of principal and stability of interest, and as a way to avoid intrusion into private markets. It also has been regarded as a way to avoid the political influences that would be inherent in investing outside the U.S. government. Generally, the goal espoused has been to place the trust funds in the same position as any long-term investor seeking a safe rate of return by investing in U.S. securities, and neither advantage nor disadvantage the trust funds relative to these investors or other parts of the government.

For most of the program's history, interest income to the trust funds has not been a major factor in program financing. In recent years, however, the increasing role of interest income, as well as interest by some policy makers in preventing any surplus Social Security tax revenues from being used for other government spending purposes, have focused attention on alternative investment practices. For example, there have been proposals to replace the special issues held by the trust funds with marketable federal securities, as well as proposals to allow any surplus Social Security tax revenues or a portion of trust fund reserves to be invested in assets other than U.S. government obligations, including equities.