For years, rumors have been circulating that Social Security is on the verge of going bankrupt. So let's get the following out of the way: Social Security is by no means going away, and the reason boils down to the primary source of its funding, which are payroll taxes. As long as we have a workforce, the program will keep collecting revenue, and will thus continue to exist.
But that doesn't mean Social Security is in good shape. Quite the contrary: According to the latest trustees' report, the program's Old Age and Survivors Trust Fund is expected to run dry in 2034 unless Congress takes steps to change that. Assuming that doesn't happen, future recipients are looking at a 21% cut in scheduled benefits once that fund is exhausted.
Now the silver lining, if we want to call it that, is that previous projections called for a 23% reduction in benefits, thereby making a 21% cut a modest improvement. Still, the overall picture is somewhat bleak for seniors, both current and future, who rely, or plan to rely, on those benefits to provide the bulk of their income.
And make no mistake about it: There's a large chunk of seniors today who depend on those benefits in the absence of independent savings, pensions, or other sources of income. In fact, 34% of current retirees count on Social Security for 90% to 100% of their income. Therefore, to lose any portion of those benefits would be downright catastrophic.
But let's not gloss over the fact that Social Security was never designed to sustain retirees by itself anyway. In a best-case scenario -- meaning, the program somehow manages to continue paying scheduled benefits in full -- Social Security will replace about 40% of the average earner's pre-retirement income. Most seniors, however, need double that amount to live comfortably in retirement, and that's not because they're traveling the globe or hitting the town night after night. Rather, when we consider the costs retirees face, from housing to food to healthcare, it's easy to see that they're not substantially lower than what they were prior to retirement.
Furthermore, while that 40% income replacement figure applies to average earners, Social Security will do even less for higher earners in retirement. Throw in the fact that benefits might get slashed substantially in a mere 16 years, and it builds a pretty strong case for saving independently -- and aggressively.
Social Security alone won't cut it
Not only is Social Security not designed to help seniors cover all, or even the bulk, of their living expenses, but its annual cost-of-living adjustments (COLAs) have been doing a poor job of helping seniors maintain their buying power through the years. Over the past half-decade, COLAs have averaged just over 1%, which is well below the general rate of inflation. When we consider that benefits aren't enough to live on, and don't increase at a helpful rate, it makes the need to establish a nest egg all the more clear.
Where do you start? If you have access to an employer-sponsored 401(k), sign up and contribute as much of your earnings as you can, keeping in mind the annual limits of $18,500 for workers under 50 and $24,500 for those 50 and older. If your company doesn't offer a retirement plan, open an IRA and aim to max out, or at least get close. The current annual limits for IRAs are much lower than those of 401(k)s -- $5,500 for workers under 50 and $6,500 for those 50 and over.
Now it stands to reason that the longer you have between now and retirement, the more you should accumulate, even if your monthly contributions are fairly modest. Case in point: Saving $400 a month in either an IRA or 401(k) over 40 years will give you $958,000 if your investments generate an average annual 7% return during that time (which is a few points below the stock market's average). If you're older, however, you'll need to do better if you want to retire with a similar level of savings. But if you're 50 years old and are willing to retire at 70, contributing $1,950 a month at that same return will leave you with a similar ending balance.
No matter how much you're able to save on a regular basis, the key is to recognize the need for it as soon as possible and start making it a priority. Regardless of whether Congress intervenes to fix Social Security, the program itself won't sustain you during your senior years. And the sooner you acknowledge that one glaring shortcoming, the better positioned you'll be to salvage your retirement.