April is National Social Security Month. With the future of Social Security in question, financial planning will become increasingly important for those seeking a secure retirement.
Social Security has long been the cornerstone of American retirement.
According to the Social Security Administration, nearly 67 million Americans will receive monthly Social Security benefits in 2023. Meanwhile, approximately nine out of ten seniors aged 65 and older were collecting Social Security benefits as of December 31, 2022.
Indeed, many older Americans rely on Social Security as a key source of income in retirement. Yet with recent projections showing the program’s reserves are likely to run out by 2033—one year sooner than previously estimated—Social Security may no longer be the retirement bedrock it once was.
The future of Social Security may be uncertain for some time. Nevertheless, careful financial planning will be necessary for those who hope to retire comfortably one day.
How Social Security Works
In the United States, Social Security is a federal government program that provides retirement, disability, and survivor benefits to eligible individuals.
Employers and employees pay into the system through payroll taxes. Currently, employees contribute 6.2% of their income, and employers pay an additional 6.2% for each employee.
Meanwhile, self-employed individuals pay the entire 12.4% payroll tax. In 2023, payroll taxes apply to up to $160,200 of a taxpayer’s annual income.
When you pay Social Security tax, you aren’t paying into an individual account designated for your retirement. Instead, taxpayers contribute to a Social Security Trust Fund that pays the benefits of all current beneficiaries.
Thus, there’s no guarantee the money you contribute to Social Security will be there for you when you retire.
Why the Future of Social Security Is in Peril
In 2020, the Social Security Trust Fund had an annual surplus of $10.9 billion, increasing reserves to $2.91 trillion. Yet the outlook for Social Security has worsened more recently.
In 2021 and 2022, the Trust Fund ran a deficit of $56.3 billion and $22.1 billion, respectively. There are several reasons the future of Social Security is now in peril.
First, the state of the Social Security Trust Fund depends on the worker-to-beneficiary ratio. When this ratio is healthy, the amount of money the SSA collects through payroll taxes exceeds the amount it pays out in benefits and vice versa.
While the birthrate has fallen in recent decades, there’s also been a wave of retirements among Baby Boomers, the largest generation of workers in American history. That means there are fewer workers paying into the system to fund Social Security benefits.
To put this in perspective, there were 5.1 workers per Social Security beneficiary in 1960. Today, that ratio has fallen to 2.8 workers per beneficiary.
At the same time, the average life expectancy for Americans has increased over time.
When Social Security began in 1935, workers who started collecting benefits at age 65 were only expected to live another 12.5 years. By 2030, these projections rise to 21.6 years for women and 19.2 years for men.
That means not only are there more beneficiaries today, but beneficiaries are collecting benefits for a longer period, on average.
Finally, the future of Social Security is in jeopardy more recently due to an economic slowdown, persistent inflation, and weaker productivity growth. According to the Wall Street Journal, the cost of Social Security has increased by 8.7% this year to account for rising inflation.
Unless Congress takes steps to shore up the program, beneficiaries will soon see their benefits decrease.
Will Social Security Ever Dry Up Completely?
The last time Social Security faced a reserve deficit was in 1983. At that time, massive bipartisan legislation was necessary to resolve the solvency issue.
Among other changes, Congress gradually increased the full retirement age from 65 to 67. In addition, they began to tax Social Security benefits as ordinary income for high-earning beneficiaries.
Following these events, Social Security became “the third rail of American politics.” Meaning, Social Security is the one entitlement program policymakers know not to touch.
Unfortunately, this also means politicians haven’t done much to address the future of Social Security since. With a potential crisis now on the horizon, a solution is imperative for the Social Security Administration to continue paying full benefits.
Congress is set to initiate spending talks later this year. However, changes to Social Security and Medicare are off the table as they relate to raising the national debt ceiling.
Essentially, Congress has three options. It can cut Social Security benefits, increase taxes, or enact a combination of the two.
According to the Social Security Trustees’ report, payroll taxes would need to immediately increase from 12.4% to 15.84% to keep the program solvent for the next 75 years. This tax would continue to be split between employee and employer unless you’re self-employed.
Meanwhile, the report also noted that an immediate 21.3% reduction in benefits would stabilize the program without raising taxes.
Preparing for an Uncertain Future
Ultimately, the future of Social Security depends on Congress’s ability to agree on a course of action. Given the potential political implications, it seems unlikely that either party would let the Fund dry up altogether.
Still, waiting on Congress to shore up Social Security may not be wise, especially if you’re nearing retirement age. Instead, you may want to consider boosting your retirement savings to account for a potential reduction in benefits.
For example, make sure you’re maxing out your contributions to your employer-sponsored retirement plan and/or individual retirement account (IRA). In 2023, individuals can contribute up to $22,500 to a 401(k), 403(b), and most 457 plans.
You can also contribute up to $6,500 to a Roth or Traditional IRA ($7,500 if you’re aged 50 or older). Even if you can’t contribute up to these limits, adding to your retirement savings each month can yield meaningful results over time.
In addition, if your employer matches your retirement plan contributions, make sure you’re contributing at least enough to meet the match requirements. Otherwise, you’re leaving money on the table.
Lastly, it’s important to invest your retirement savings to grow your nest egg and outpace inflation over time.
Qualified retirement accounts offer certain tax advantages that allow you to grow your funds tax-free until you withdraw them in retirement. This benefit amplifies the power of compounding, which can boost your savings long-term.
Comprehensive Financial Planning Is Essential for a Secure Retirement
Though Social Security may never dry up completely, it’s possible your benefits will be much smaller by the time you reach retirement age. No matter the future of Social Security, careful financial planning is key for a successful retirement.
Consider working with a trusted advisor to develop a comprehensive financial plan for your future. We can help you identify and implement strategies to preserve and grow your money over time, so you don’t outlive your financial resources in retirement.
To see if we may be the right fit for your financial planning needs, please contact us. We’d love to hear from you.