According to the Social Security Administration's June 2016 snapshot, some 60.5 million people, two-thirds of whom are retirees, are currently receiving Social Security benefits. For retired workers, that benefit works out to an average of $1,348.49 per month.
On the surface it may not sound like a lot, but Social Security benefits provide at least half of all monthly income for 48% of married elderly couples, and 71% of unmarried elderly individuals rely on Social Security income for at least half of their monthly income. Simple translation: Social Security is a critical program for our nation's seniors.
Here's why Social Security is in trouble
Unfortunately, Social Security's long-term foundation is shaky. The Fund that pays out these 60.5 million people each month, the Old-Age, Survivors, and Disability Insurance Trust (OASDI), is slated to run out of its $2.8 trillion in spare cash by the year 2034, according to the 2016 Trustees report. By 2020 the program will begin burning through its excess cash reserves, potentially leading to a benefits cut of up to 21% by 2034. If you're one of those aforementioned couples or individuals who's reliant on Social Security for at least half of your monthly income, or you're heading into retirement with very little in savings, this is a terrifying forecast.
The tricky thing is that Social Security isn't just wrestling with one crisis -- it has four big problems that it's contending with.
1. A falling worker-to-beneficiary ratio
One of the biggest problems facing Social Security is a demographic shift -- namely the retirement of baby boomers. Between 2010 and 2030 we're liable to see more than 70 million baby boomers enter retirement, which means a big surge in the number of eligible beneficiaries. The architects of Social Security simply couldn't predict there would be such an incredible surge in birth rates.
On the flipside, there just aren't enough new workers in the labor force to replace retiring boomers. Between 2015 and 2035, the worker-to-beneficiary ratio is forecast to fall from 2.8-to-1 to as low as 2.1-to-1. In short, there won't be enough payroll tax revenue coming in to support the growing number of beneficiary payments heading out.
2. Rising life expectancies
Another big demographic shift for the program relates to rising life expectancies. In the mid-1960s, the life expectancy of the average adult in the United States was about 70 years. By the mid-2010s, life expectancies had risen to 78.8 years. This improved life expectancy can be attributed to better health education, growing access to medical care, and improved pharmaceutical options.
Once again, the architects of Social Security didn't predict that life expectancies would improve by as much as they have. The result is we have people living longer than ever, and able to draw Social Security payments for an extended period of time.
3. Near-record-low bond yields
An under-the-radar issue for Social Security has been falling interest rates.
For the consumer and businesses, falling interest rates have been a blessing. Near-record-low rates have allowed homeowners to refinance their mortgages, and new homeowners to purchase homes with low 15- or 30-year mortgage rates. Businesses have also been able to expand, hire, and make acquisitions for an exceptionally low cost.
Low interest rates have had the opposite effect on people and funds looking to make money from fixed-income assets. The OASDI specifically invests in special issue bonds available only to Trust funds, as well as a small number of certificates of indebtedness. In the coming years we're going to see bonds yielding 3.5%+ maturing, leaving the Trust invested in special issue bonds with low yields that may not top the inflation rate. The longer the Federal Reserve keeps rates near historic lows, the less interest income the OASDI will generate, and the quicker the program could burn through its spare cash.
4. Congressional stalemate
The final big issue for Social Security is that Congress doesn't seem to be in any rush to correct what looks to be an imminent cash shortfall for the program. Despite having more than a dozen Social Security fixes to choose from, including multiple options to raise revenue through taxation, as well as reduce benefits, Congress hasn't made any progress on getting a solution implemented. As long as Congress continues to push a Social Security solution under the rug, consumers are the one's who'll suffer.
The one thing you should be doing
With Social Security's long-term outlook uncertain, and a cut of up to 21% looming by 2034, now more than ever millennials and Gen Xers need to find ways to broaden their income channels come retirement. The easiest and smartest way to do this is by utilizing tax-advantaged investment vehicles.
If your employer offers a 401(k) through work, it could be a good option to get your retirement nest egg off the ground. In 2016, workers aged 49 and under are allowed to contribute up to $18,000 toward their 401(k), while workers aged 50 and up can contribute up to $24,000. The extra $6,000 represents the catch-up contribution for those people who are nearing retirement. Being able to contribute so much annually can ensure you aren't too reliant on Social Security income during retirement.
Furthermore, quite a few companies offer to match a percentage of their employees' annual income as both a loyalty incentive and an effort to get their employees on the right track to retirement. Taking advantage of these matching contributions is usually a smart idea since it's essentially free money.
Additional options include contributing to a Traditional IRA or Roth IRA. Both Traditional and Roth IRAs allow for a $5,500 annual contribution for persons aged 49 and under, and $6,500 for those aged 50 and up. However, there are marked differences between these plans, and it's up to you to decipher which one better suits your needs.
A Traditional IRA allows your money to grow on a tax-deferred basis, and money contributed is treated as pre-tax funds. This means your taxable income is reduced by the amount of your contribution, which could help boost your current year tax refund, or reduce your liability. The downside, as with a 401(k) which is a tax-deferred plan, is that you'll owe tax once you begin making eligible withdrawals during retirement.
On the other hand, money contributed to a Roth IRA is from after-tax funds, meaning there's no upfront tax benefit. However, investment gains within a Roth are completely free and clear of taxation as long as you make no ineligible withdrawals. Over time, the back-end tax benefit of a Roth will often outpace the upfront tax benefits of a Traditional IRA. Just be aware that income limits are in place -- $132,000 for an individual and $194,000 for joint filers in 2016 -- that could disallow you from contributing to a Roth IRA.
Social Security may not be on solid footing, but that's no reason for you to worry if you have alternate income channels firmly in place.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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