- Social Security is designed only to replace some of your income in retirement
- If no changes are made, Social Security benefits are projected to drop by 23% by 2034
- Several options are being considered to strengthen Social Security, though some are politically unpopular
- Today’s workers should proactively plan a retirement strategy that is structured to succeed regardless of what happens with Social Security
Many workers—especially younger ones—wonder how much they should expect to receive from Social Security when they retire, or if they should count on anything at all. Every year, dire warnings predict¹ that the Social Security Trust Fund² will run out of money within a few years.
Does that mean reduced checks? No checks? Should people close to retirement file for Social Security as soon as possible to ensure they receive something?
To better answer those questions, it’s important to understand the history of Social Security and how it works.
What is Social Security?
In the depths of the Great Depression, President Roosevelt signed into law the Social Security Act of 1935. At the time, it was designed to be a social insurance and anti-poverty program for retired workers over 65. Although, today, workers can begin collecting a reduced amount from Social Security at age 62.
Social Security benefits have expanded over the years to include benefits for survivors (spouses and children) and people with disabilities who are unable to work for more than one year.
For the average American, Social Security benefits will replace roughly 40% of pre-retirement income when they retire. With so much on the line, it’s important to understand the health of the program and, more importantly, what it can mean for your future income and retirement.
How does Social Security work?
Social Security is funded by a payroll tax that workers and employers pay on earnings of up to $147,000. That amount, called the Social Security wage basis, is adjusted every year.
Employers and employees split the bill, each paying 6.2% of wages for a total tax of 12.4%¹. Self-employed individuals end up paying both parts of the tax. Even employees whose earnings are too low to owe income taxes must still pay for it.
Those tax revenues are then used to make monthly benefit payments to people currently receiving benefits.
Any unused revenue is placed into two Social Security trust funds—one for retirees, spouses, and surviving family members—one for people deemed to be disabled².
These trust funds are invested in interest-bearing Treasury securities². These are considered very safe but could, over time, limit the growth and sustainability of the program due to low rates of return.
To be sustainable, Social Security primarily depends on three things:
- The number of workers paying taxes to fund its benefits.
- How many people are collecting benefits.
- The returns on the money being held in the Social Security trust funds.
Who collects Social Security and how much do they get?
Eligible recipients, also called beneficiaries, fall into four categories:
- People who have already retired
- People who are disabled
- Survivors of workers who have passed away
- Dependents of recipients
The amount they collect is based on how long they paid social security taxes and their income. So normally someone paying taxes for 35 years, who makes $100,000, will receive a higher benefit payment than someone who has only worked 20 years and makes $50,000.
Benefits are adjusted annually to account for inflation (often called a COLA or cost of living adjustment). The rate of increase is based on a broad measure of inflation known as the Consumer Price Index (CPI).
By creating a Social Security account with the Social Security Administration (SSA), you can get an estimate of how much you’ll collect when you retire.
Remember that those estimates are in today’s dollars and are not adjusted for inflation, so that number could be considerably higher when you actually retire. Of course, earning more in the future will also bump up that number.
Why are people worried about Social Security?
Two major factors could have a profound impact on Social Security.
First, when Social Security began, people didn’t live as long as they do now. For example, the average life expectancy for someone aged 65 in 1940 was about 14 years. Now, it’s over 20 years.
Second, decades ago, there were more workers supporting retirees than now. Back in the 1940s, there were 160 workers for every person collecting Social Security. Currently, that number has dropped to 2.8.
Every year, the trustees of Social Security and Medicare release a report on the financial health of both programs. The most recent Trustees’ report³ showed that the trust fund will be depleted by 2034.
When that happens, the ongoing tax payments would only cover around 77% of benefits for the next 75 years (which is as far out as they make projections)³.
The good news is that some benefits can still be paid. The bad news is that future benefits might be reduced—at least for those that rely on benefits for their livelihood.
What are the options to improve Social Security?
The good news is that Congress has several options to improve the finances of Social Security, though all of those options may be politically challenging.
Here are the possibilities:
- Increase the retirement age: Life expectancy has increased since the 1930s. The full retirement date could be pushed back to help offset that increase, or there could be a greater benefit reduction if they are taken early (before full retirement age).
- Means test retirement benefits: Retirees could receive reduced or no benefits if they have sufficient assets or income from other sources.
- Increase the tax rate on wages: The tax rate (6.2% for both employers and employees) could be increased to generate additional tax revenue.
- Increase or eliminate the Social Security wage base: As noted above, only the first $147,000 of a worker’s income is currently taxed; increasing or eliminating that ceiling would generate additional revenue to fund future benefits.
- Allow trust fund assets to be invested: Requiring all trust fund assets to be invested in Treasury securities means there is historically very little return and growth potential for the assets. Allowing trust fund savings to be invested in more diverse assets, such as stocks or real estate, could potentially allow the accounts to grow to meet future needs.
Can you rely on Social Security? What should you do?
As noted above, when the trust fund is depleted in a decade or so, benefits are projected to be reduced to roughly 77% of what they are today if no changes are made.
This means that you may rely on Social Security, but you likely shouldn’t rely on the full amount that the Social Security Administration estimates now.
Keep in mind that for people making over $100,000, Social Security is estimated to replace less than 30% of their income in retirement (the current average monthly benefit is $1,669).
While your SS benefit may be a smaller amount of retirement income, imagine if 10-20% of your current income vanished overnight.
With such an income source at risk, it’s imperative to create a plan today that is designed to achieve financial security and independence no matter what happens to to the program.
Putting your future in a struggling benefits program's hands can jeopardize your retirement.
Proactive planning, saving, and investing can put you in better control of your financial security and independence in the future, helping to eliminate the need to rely on Social Security for a successful retirement.
With a financial plan that evolves over time, you can adapt your savings and investing strategy as you get closer to retirement and have greater clarity around whether or not Social Security will be a reliable source of income in the future.
A CFP® Professional at Facet can help you create proactive, ongoing financial planning that can evolve as your life changes.