Social Security is 16 years away from big trouble. That's the rough message from the Social Security Board of Trustees' 2019 report, which came out months ahead of when it's usually released.

Social Security, which currently provides benefits to 63 million Americans and is responsible for accounting for at least half of the monthly income of more than 3 out of 5 retired workers, has been facing hardships for quite some time now. In each and every annual report from the Trustees since 1985, it's been forecast that the program wouldn't bring in sufficient income to cover expenditures over the long term, which is defined as the next 75 years. In simple terms, if there's not enough money to cover costs, it suggests that benefit cuts are coming.

A person tightly gripping a Social Security card between their thumb and index finger.

Image source: Getty Images.

According to the newest report, Social Security bucked the 2018 forecast of a $1.7 billion net cash outflow from the program and actually brought in a $3.1 billion net cash surplus. A stronger economy certainly helped bolster payroll tax collection in 2018. However, it's still worth noting that the $3.1 billion in net cash surplus was the smallest increase in Social Security's asset reserves (i.e., its aggregate net cash surpluses since inception, which are currently invested in interest-bearing special-issue government bonds) since the last major overhaul of the program in 1983.

The Trustees now predict that Social Security will again generate a net cash surplus in 2019, albeit it'll shrink even further, to just $1 billion, by year's end. This would increase the program's asset reserves to a peak of nearly $2.9 trillion.

But then the you-know-what hits the fan.

Beginning in 2020 and for each subsequent year thereafter, Social Security is projected to spend more money than it collects. This means, little by little, the money that's been built-up since inception and invested into these special-issue bonds will begin to dwindle. Based on projections from the Trustees, this almost $2.9 trillion in asset reserves will be completely gone by 2035, one year later than it predicted last year and the 23rd time the depletion date has changed since 1985.

What does all of this actually mean for you, whether you're currently receiving benefits, on the verge of applying for benefits, or still perhaps decades away from hitting the eligible retirement age? Let's take a closer look.

A senior man counting a fanned pile of cash bills in his hands.

Image source: Getty Images.

Social Security's 2035 asset reserve depletion date: Here's what it really means

The language of the report and the subsequent headlines from major news outlets are probably scary -- and for good reason. Since most folks are reliant on Social Security for a significant portion of their income during retirement, they just assume that the program's asset reserves running dry by 2035 means Social Security won't be there for them when they retire. Thankfully, though, this couldn't be further from the truth.

Social Security is funded in three separate ways:

  • A majority of the income generated for the program comes from the 12.4% payroll tax on earned income of up to $132,900 in 2019. This figure, known as the payroll tax cap, adjusts upward on par with the National Average Wage Index almost every year. The exception is in years where no cost-of-living adjustment is passed along to beneficiaries. In 2018, the payroll tax was responsible for a little over 88% of all revenue collected.
  • Next up is the taxation of Social Security benefits. If a single taxpayer's modified adjusted gross income (MAGI) plus one-half of their Social Security benefits exceeds $25,000, or $32,000 for a couple filing jointly, up to half of these benefits could be taxed at the federal level. This tax, introduced in 1983 and implemented in 1984, yielded a second tier of taxation in 1993 that allowed up to 85% of an individual's or couple's benefits to be taxed at the federal level if exceeding $34,000 or $44,000, respectively, using the same MAGI plus one-half benefits formula. In 2018, the taxation of benefits generated about 3.5% of all income.
  • Lastly, there's the interest income the program collects on its nearly $2.9 trillion in asset reserves. By law, these asset reserves are required to be invested in special-issue bonds, with Social Security spreading this excess money out over a multitude of maturities and available yields. In 2018, a little over 8% of total revenue came from net interest income.

If and when Social Security's asset reserves disappear, there would no longer be any interest income generated for the program. However, the payroll tax and taxation of benefits would remain in place. Since these income sources combined for almost 92% of total revenue collected last year, Social Security would still have plenty of cash flowing into the program for disbursement.

In other words, payments are going to continue for a very, very long time to come. About the only thing that would actually compromise Social Security's long-term solvency would be if Congress changed how the program was funded.

Scissors cutting through a $100 bill.

Image source: Getty Images.

And now, the bad news

So the good news is that you can expect a Social Security benefit when you retire, presuming you have the 40 requisite lifetime work credits to receive a retired worker benefit. The bad news is, your benefit could be smaller than you expected as a result of changing demographics.

Once Social Security's asset reserves are gone, it essentially becomes a cash-neutral program, assuming no amendments to the program are passed by Congress. The Social Security Administration (SSA) would need to reduce benefits across the board -- meaning for then-current and future beneficiaries -- to account for its growing expenditures. According to the Trustees, this means reducing benefits by as much as 20% in 2035 (and beyond). Should this happen, the average Social Security benefit for retired workers would drop relatively close to (but still remain above) the federal poverty level, in 2019 dollars.

Ultimately, the SSA recommends that the average retiree count on Social Security to replace about 40% of their working wages during retirement, with lower-income folks perhaps leaning to a slightly higher percentage and well-to-do workers seeing a lower percentage of replacement. The point is that the SSA doesn't view Social Security as a primary source of income, and neither should you.

So that's the gist of the latest report: Social Security isn't going bankrupt but it's facing a pretty steep funding shortfall of $13.9 trillion between 2035 and 2093 if benefits aren't cut from current levels.

The bigger question at this point is this: When is Congress going to do something about this mess?