The Social Security program is vitally important to the financial well-being of our nation's retired seniors. According to statistics from the Social Security Administration, more than three in five seniors, as well as 71% of unmarried elderly retirees receiving benefits, count on Social Security to provide for at least half of their monthly income. Without this guarantee of monthly income, it's reasonable to assume that millions of senior would be struggling to make ends meet in retirement.

But this vital program has a very big problem: It'll soon be paying out more in benefits than it's generating in revenue.

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How Social Security generates its money

Social Security is funded three ways: payroll taxes, interest earned on its asset reserves, and through the taxation of benefits. 

Payroll taxes comprise the bulk of Social Security's revenue generation. In 2015, the 12.4% payroll tax (of which workers usually pay half (6.2%) and employers pay the other half (6.2%)) accounted for more than 86% of the $920.2 billion in revenue for the program. As long as people keep working, Social Security has zero chance of going bankrupt since money will always be generated by the payroll tax to fund beneficiary payouts.

The interest earned on the $2.85 trillion currently in the Trust's asset reserves accounted for another $93 billion (about 10.1%) in 2015. Social Security's spare cash isn't something the federal government plans to play around with, so the program invests this excess money into bonds specifically issued for Trusts and into certificates of indebtedness to a far lesser extent. Like any bond, rising interest rates tend to have a positive impact on yield, so the current monetary tightening policy of the Fed is actually good news in terms of interest income generation for Social Security.

Lastly, about 3.4% of the $920.2 billion in revenue from 2015 came from taxing Social Security benefits at the federal level (yes, at least some of your Social Security benefits may be exposed to federal and/or state taxation). Single beneficiaries earning in excess of $25,000 annually, and married beneficiaries bringing home $32,000 or more annually, will see at least half of their Social Security income exposed to federal taxation.

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Why Social Security will soon deplete its excess cash

According to the Social Security Board of Trustees report from 2016, the Trust will begin paying out more in benefits than it receives by 2020. Just 17 years from now in 2034, the $2.85 trillion in asset reserves (which may actually approach $2.9 trillion by 2019 as a result of higher interest rates and cash inflows until 2020) will be completely gone.  The report suggests that the absence of this spare cash could necessitate across-the-board cuts in seniors' benefits of up to 21%.

Why is this happening, you ask?

To begin with, baby boomers are leaving the workforce in greater numbers, which is applying downward pressure on the worker-to-beneficiary ratio. Over a 20-year span between 2015 and 2035, the worker-to-beneficiary ratio is expected to fall from 2.8-to-1 to 2.1-to-1. There are simply not enough new workers, or income from those workers, to account for the rapid rise in the number of eligible retirees. But baby boomers don't deserve all, or even a majority, of the blame.

Another factor that's impacting Social Security's asset reserve decline is income inequality. Well-to-do folks typically have full access to preventative care and other medical needs because they aren't financially constrained by the high costs and rapid inflation associated with the medical industry. Lower-income folks, for which Social Security was truly created to protect, usually have less access to preventative medical care. The rich tend to live notably longer than the poor, and are thus able to receive a monthly benefit check (and a higher monthly benefit check at that) for a longer period of time.

A senior holding a stack of Social Security cash.

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Lengthening life expectancies are also to blame. Since 1983, the last time Social Security really faced a major overhaul at the congressional level, the full retirement age -- the age at which the SSA deems you eligible to receive 100% of your monthly benefit -- has risen by just a year and two months. By 2022, the full retirement age will be 67, and it'll have increased by two years in four decades. Meanwhile, life expectancies have jumped by more than four years since 1983, and they could rise further before 2022. This is allowing seniors to draw a payment for a longer period of time.

Lastly, you can probably blame the Fed a bit. Having the federal funds target rate at record lows for seven years (Dec. 2008-Dec. 2015) meant a decline in the yields of the special issue bonds that the Trust invests in. Thus, far less in interest income has been generated.

What you can do about it

There's not a lot that can be done for Social Security if Congress fails to come to an amicable solution to fix the program. But there are clear-cut actions you can take to be prepared if Social Security's asset reserves are exhausted.

For example, if everyone is likely to face a cut in their payouts of up to 21% in the years to come, waiting as long as possible to claim benefits might be optimal, assuming you're in good health and able to benefit over the long term by waiting until your full retirement age or after to sign up. Since your payout grows by 8% annually from age 62 until age 70, waiting until age 70 could net you a 24% to 32% additional monthly payout on top of the 100% you're due at your full retirement age. Even after a 21% pay cut, you'll still be netting around what you would have at your full retirement age.

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More importantly, it's in the best interest of today's workers who'll be retiring in 10, 20, 30, or even 40 years to not rely on Social Security as a primary income source in retirement. This means formulating and sticking to a budget to optimize your ability to save, as well as taking some of what you've saved and investing it in the greatest wealth creator of our time, the stock market. While the stock market will have its inevitable hiccups, it's also returned an average of 7% annually, including dividend reinvestment, over the long term.

The best way to reduce your chance of being impacted by Social Security's asset reserve depletion is to distance yourself from relying on Social Security as a major component of retirement income from the start.

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