Millions of seniors depend on Social Security to stay afloat financially in retirement, but there's been a lot of talk in recent years about the program going bankrupt. So let's start with some good news: Contrary to rumors, Social Security is not in the process of going broke. The reason? The program is primarily funded by payroll taxes, which means that, as long as we keep taking taxes out of workers' paychecks for Social Security purposes, there will be a means of paying benefits.
However, Social Security is facing some financial challenges that could leave seniors deep in the lurch in the coming years. Here's why a cut in benefits might come to be an unwanted reality -- and sooner than today's recipients might be expecting.
Social Security's financial woes
Social Security has long been using its excess revenue to build its trust funds. Think of those funds as money for a rainy day -- kind of like a massive emergency fund, if you will. The problem, however, is that the program already is dipping into its trust funds because its financial obligations are exceeding its incoming revenue. (We can thank the mass exodus of older employees from the workforce for that, combined with lower worker-replacement rates that can't keep pace).
Those trust funds are enabling Social Security to pay its currently scheduled benefits. But once those funds run out, recipients face major cuts unless Congress comes up with a fix.
Unfortunately, based on the latest Trustees Report, those funds might run dry as early as 2034. And once that happens, recipients might see as much as a 21% reduction in their benefits. For those who rely on Social Security to pay the bulk of their bills, that could spell the difference between keeping up with their expenses and teetering on the edge of poverty. And that's not a great spot to be in.
Hope for the best, prepare for the worst
Now let's be clear: Because so many seniors stand to face serious financial hardships if benefits get cut, lawmakers are motivated to devise a solution to the glaring problem at hand. But a solution is by no means guaranteed, which means it's on the backs of individuals who currently or eventually will rely on those benefits to compensate for any shortfall.
If you're not yet retired, the solution is simple: Save more for the remainder of your career. Currently, workers under 50 can sock away up to $19,000 a year in a 401(k) and $6,000 a year in an IRA. For workers 50 and over, these limits rise to $25,000 and $7,000, respectively. If you can't max out either type of account, save at a higher rate than you've been saving at to date. Increasing your monthly contributions by just $50, for example, will give you an extra $24,600 to work with in retirement if you do so over a 20-year period and your invested savings generate an average annual 7% return during that time. Make it an extra $100 a month, and you'll be looking at an additional $49,200 for retirement, all other things being equal.
Of course, if you're already retired, you're in a completely different (and much more precarious) boat. After all, it's hard to pad your nest egg when you're used to living off of your nest egg. But what you can do is cut back on living expenses in the coming years to build some cash reserves, and start doing some type of part-time work to generate additional money. Putting in just a few hours of work each week could help you build a solid cushion, especially if you manage to invest that money wisely.
Each year, millions of seniors eagerly await news of a cost-of-living increase for their Social Security benefits. The unfortunate reality is that, come 2034, the opposite might occur -- we might see a drastic reduction in the amount recipients are able to collect. The sooner we all take steps to prepare for that scenario, the more seniors will manage to preserve their finances at a time when they're otherwise vulnerable.