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Retirees: Social Security Benefits Are Replacing Less Income

By Christy Bieber – Jul 28, 2021 at 5:11AM

Key Points

  • Social Security benefits are meant to replace around 40% of pre-retirement income.
  • By 2035, they will replace less than 30%.
  • There are three big reasons why the effective value of Social Security benefits is falling.

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Find out what's going on and why it's happening.

Social Security benefits aren't an adequate source of retirement income without additional savings to support you. There's a simple reason for that: They replace a pretty small percentage of your pre-retirement earnings. 

Unfortunately, that percentage is rapidly shrinking. According to the Center for Retirement Research, Social Security replaced about 41% of pre-retirement income in 1995 after accounting for Medicare premiums and taxation of benefits. But by 2035, that number will be down to just 29%.

Below, you'll learn about three factors that are contributing to what could be a disastrous reduction in retirement income for those who rely on Social Security.

Retiree preventing piggy bank from being snatched away.

Image source: Getty Images.

1. Full retirement age is changing

The amount of Social Security retirees receive depends on when they first start getting checks. Seniors must start benefits at full retirement age (FRA) if they want their standard benefit. And FRA is gradually getting later.

For those born in 1955, it is 66 and 2 months. But those born in 1956 have an FRA of 66 and four months. It will move ahead by two months each year until everyone born in 1960 or later ends up with an FRA of 67. 

This change to FRA ends up resulting in an effective benefits cut for future retirees. That's because early filing penalties reduce benefits for each month someone claims before FRA. Someone with a later full retirement age must either wait longer to get their full benefit (giving up income in the interim) or accept a smaller monthly check.

A later FRA also means fewer opportunities to receive delayed retirement credits, which raise monthly checks for each month a retiree delays the start of them between FRA and age 70. With retirees forced to wait longer to claim benefits or to accept a smaller check, it's no wonder Social Security won't replace as much of their pre-retirement earnings. 

2. Medicare premiums are rising

Medicare premiums are rising due to healthcare inflation. These premiums are typically deducted from people's Social Security checks, reducing the net value of their retirement benefits. 

Social Security retirees get periodic cost of living increases, which are supposed to protect them from a reduced buying power due to inflation. But the Cost of Living Adjustments (COLAs) are calculated based on a measurement of inflation that underestimates the percentage of income seniors devote to medical care.

The result: Medicare premiums are going to take an increasingly big bite out of Social Security checks, eating up a large portion of a retiree's COLAs and resulting in benefits not replacing as large a percentage of income once the costs of Medicare are deducted. 

3. More benefits will be taxed

Finally, a growing number of retirees will be subject to federal tax on Social Security, which also reduces the net value of their benefits. That's because the thresholds at which benefits are taxed are set in stone and don't change each year to reflect wage growth. 

People, on average, typically earn a little bit more each year as wages go up over time. Since Social Security benefits are based on average wages, the average benefit also goes up a little bit each year. So, since the dollar amount above which benefits are taxed doesn't change, more people cross over the threshold and end up owing money to the IRS.

Of course, if more Social Security benefits are being sent to Uncle Sam to pay a tax bill, the amount left over will replace less income. 

Sadly, there's little seniors can do to stop any of these three changes. But future retirees can and must plan for their benefits to reduce a smaller percentage of their take-home pay. This means retirees need to save extra cash for their later years so retirement investments provide more supplementary income to make up for the reduced role Social Security will play in their support. 

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