Will Social Security run out of money? Should I rely on it as part of my retirement income? You may have heard warnings about this dire scenario. These warnings, however, assume that no action will be taken to address Social Security’s financial challenges between now and then. So, what’s the real risk of Social Security disappearing? Let’s look at this question and a few other commonly asked questions about this commonly misunderstood part of retirement planning.
What is Social Security and how is it funded?
Social Security, or Old-Age, Survivors, and Disability Insurance (OASDI), replaces a percentage of your income based on your lifetime earnings. While it isn’t intended to be your only source of retirement income, it plays a valuable role for many retirees.
Social Security is funded through a tax on your income up to $160,200, a limit often called the “Social Security wage base”. You and your employer each pay 6.2% of your income up to the limit, for a total of 12.4%. If you’re self-employed, you pay the full 12.4% yourself.
Will Social Security run out?
Unlike a 401(k) or IRA where you save into a separate account for yourself over time, Social Security relies on tax revenue from current workers to pay benefits to current retirees. This works in principle if the tax revenue meets or exceeds the amount that retirees are owed. However, birth rates have declined since the baby boom between 1946-1964, leading to fewer current workers and retiree benefits that exceed new tax revenue.
Without changes, the Social Security program runs the risk of running dry. According to CNBC, only 85 cents of every tax dollar you pay goes to the Social Security Trust, which pays benefits to current retirees. The other 15 cents go to pay benefits for people with disabilities. The trust fund has had a surplus in recent years but, this is projected to run out by 2034 and tax revenue will only meet 77% of benefits owed.
So, in short, if no changes are made, retirees will face a steep cut to their benefits, though some benefit would continue.
What can be done to shore up Social Security?
Congress can fill the gaps in Social Security in two primary ways: increasing tax revenue and cutting benefits.
Increasing tax revenue
Raising taxes brings more income to the plan and would help close the gap, though it’s more painful to those bearing the increased tax burden. The 6.2% on employees and employers has been constant since 1990, but the “wage base” has steadily increased over time and would likely be the easiest way to increase overall revenue. We’ve already seen tax proposals that would significantly increase the ceiling on taxed income for earners over $400,000.
Cutting benefits
Revisions to current benefits aren’t likely to affect current retirees as proposals in recent years have been limited to those under age 50 or so. The income percentage or annual cost of living adjustments could be decreased but the most likely revision is a change to the “full retirement age” when you’re eligible to receive full benefits. Social Security originally set full retirement age at 65, but reforms in 1983 gradually increased this to age 67 and, as life expectancy continues to increase, this could be increased further.
Want to learn more about how to plan for Social Security in retirement? See When Should I Take Social Security?.
Should you include Social Security in your retirement planning?
While it’s unlikely that social security will disappear entirely, we recommend taking a conservative approach to including social security in your retirement planning. In How Much You Need to Retire, we discuss how to account for fixed income like pensions and Social Security when you calculate how much you need to save.
Retirement planning relies on setting a goal number for your nest egg, which is the retirement portfolio that will pay your monthly expenses and enable you to enjoy life. When you run your retirement projections, you can assume a reduced Social Security income, perhaps something like 70% of what you currently expect to receive, and plan to build your portfolio to offset the difference. Then, if Social Security pays out the full amount, you can have a little more fun! A good surprise in retirement is far better than a bad one.
Ryan Colis
CFA, CFP®
Partner, Financial Advisor
About the Author
Ryan is a problem solver. He has a distinct ability to create a simple solution for very complex puzzles. So, naturally, he’s an integral part of our team. His favorite part of his role at Alterra is the analysis – whether analyzing a financial plan or reviewing an investment portfolio. However, the profession allows him to share that passion with clients by helping them navigate financial complexities as they collaborate on achieving their personal and financial goals.
After completing his undergraduate degree in Business Management, Ryan and Grant met by chance, developed a rapport and have been working together ever since. Ryan has continued his formal training in finance by earning his CFP and CFA designations.
The “Alterra” name was coined by joining the Latin roots “alter”, the origin of the word “altruism” with “terra” meaning earth or land. This name reflects the company philosophy of “clients before profits” and providing firmly grounded advice.