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Without Social Security income, many of today's retirees would likely struggle to make ends meet. According to a national poll conducted by Gallup in 2015, 59% of retired seniors count on Social Security benefits to be a major source of monthly income, while another 31% rely on their Social Security benefits as a minor source. That's 9 in 10 seniors who could, in some way, struggle to make ends meet if that income were taken away.
For seniors, there may be no more pressing issue than ensuring that Social Security continues to pay benefits for years and decades to come. Unfortunately, the program's Judgement Day is quickly approaching.
Social Security's architects didn't anticipate this
According to the 2016 Social Security Board of Trustees' report on the health of the program, the Old-Age, Survivors, and Disability Insurance Trust (OASDI), which is what pays benefits to more than 60 million beneficiaries each month, could deplete its spare cash reserves by the year 2034. The OASDI currently has just north of $2.8 trillion in spare cash that's being invested in special-issue bonds. Though the program will bring in more revenue via payroll taxes than it pays out through 2019, by 2020 the tide will shift and the program will begin to hemorrhage cash. By 2034, the Board of Trustees forecasts that this spare cash will be fully depleted.
A number of demographic shifts can be blamed for Social Security's imminent fiscal woes. Front-and-center is the retirement of some 70 million-plus baby boomers over the next two decades. Social Security was never designed to anticipate the surge in births witnessed post-World War II, leading to a strain on the program and a crippling reduction in the worker-to-beneficiary ratio.
Also hurting Social Security is the fact that people are living longer than ever. Improved health education, access to health insurance, and better medicines have pushed the average life expectancy to nearly 79 years. That's about a nine-year improvement in five decades. When Social Security was put into place, its founders didn't envision life expectancies rising so substantially or rapidly. The result is more elderly Americans than ever are drawing Social Security payments for a longer period of time.
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Got $32 trillion? The Social Security Administration could use your help
The Board of Trustees report pegged the official 75-year shortfall at $11.4 trillion through 2090, a $700 billion increase from the projected $10.7 trillion revenue shortfall implied by its 75-year outlook through the year 2089 in last year's report. However, this 75-year timeframe only tells part of the story.
The actuaries that compile these estimates have a separate measure known as the "infinite horizon projection" that takes into account all annual balances and expenses of the OASDI beyond the 75-year mark. Looking beyond 2090 into perpetuity, and assuming the same demographic and economic changes that are apparent in the 75-year estimate continue, the Trustees estimate that Social Security's underfunded obligations total a staggering $32.1 trillion as of 2016, in present value dollars. Based on the current population of the U.S., this works out to approximately $99,000 for each man, woman, and child.
What's potentially more worrisome is that the infinite horizon projection shortfall has been skyrocketing. The shortfall under the infinite horizon model increased by $6.3 trillion in 2016 from 2015, and it's doubled from the $16.1 trillion shortfall estimated by the SSA's actuaries in 2010. The reason behind the substantial increase in recent years can be tied to historically low lending rates. The lower long-term lending rate forecasts go, the less interest income the OASDI can earn with its spare cash, and the higher the budgetary shortfall could be over the very, very long-term.
It is worth mentioning that the further the forecasts go out, the less reliable they'll presumably be. Nonetheless, the key takeaway from the 2016 Board of Trustees report is that Social Security's funding shortfall could be much higher than originally anticipated.
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Actions you should be taking now
Despite Congress having swept Social Security's issues largely under the rug for the time being, there's no denying or ignoring the fact that significant changes will be needed to sustain the Social Security program for generations to come. The Trustees report suggests that benefit cuts of up to 21% could be needed by 2034 to maintain benefits through 2090, and my guess is most seniors can't avoid to take such a steep and sudden cut to their income.
If you're a working American or a baby boomer getting ready to retire over the next two decades, then you should be taking actions now to prepare for a possible cut in your Social Security benefits in less than two decades.
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First of all, you should have alternate sources of income beyond just Social Security. The most popular option, beyond just putting money in a regular brokerage account, is to contribute to tax-advantaged retirement accounts, such as an employer-sponsored 401(k), Traditional IRA, and/or Roth IRA.
The first two tax-advantaged tools -- the 401(k) and Traditional IRA -- allow your nest egg to grow on a tax-deferred basis. Money contributed to a 401(k) or Traditional IRA is considered to be before-tax funds, meaning it can lower your tax liability in the current year, saving you money. The downside, if there is one, for tax-deferred tools is that you'll be required to pay taxes once you begin making withdrawals during retirement. If you've been contributing to a tax-deferred investment tool, you'll want to take the extra time to understand your tax implications in advance of retiring.
A Roth IRA is a truly exceptional investment tool open to around 9 in 10 Americans. (Single filers making more than $132,000 in adjusted gross income (AGI) in 2016, and joint filers over $194,000 AGI, can't contribute to a Roth IRA.) The real advantage to a Roth is that money contributed is completely free and clear of taxation for the life of the account as long as you don't make any unqualified withdrawals. Taking a tax break after your nest egg has grown can often provide a bigger punch than the upfront tax break you'll find with the Traditional IRA. Plus, as icing on the cake, Roth IRA distributions don't count toward your annual income, which means your chances of having your Social Security income taxed could drop.
The other key action to take is having a Social Security game plan in place long before you retire.
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According to the Center for Retirement Research at Boston College, 45% of seniors file for Social Security benefits as soon as they're eligible at age 62, and 3 in 5 do so before reaching their full retirement age, or FRA. A person's FRA is the age that determines when they're eligible to receive 100% of their benefits, and it's based on your year of birth, with today's retirees and retirees in the future looking at an FRA of 66 years to 67 years.
Filing for benefits prior to reaching your FRA will result in a benefit reduction of up to 25% to 30%. If benefit cuts are in the offing by 2034, those seniors who filed for benefits early could really be in a pinch.
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On the flipside, seniors who wait patiently to file for benefits could be greatly rewarded. For each year that seniors hold off on signing up for Social Security, their benefit grows by 8%, up until age 70. Based on your FRA, this means someone waiting until age 70 to claim Social Security could see a payment that's 24% to 32% higher than their FRA. That extra income could help buffer against a future benefits cut, especially if you have alternate sources of income.
Long story short, Social Security is on track for an imminent cash shortfall and probable benefits cut, and you can't sit on the hands and expect Congress to save your behind. Take action today to set yourself up for the retirement you deserve.
