Social Security benefits are an important source of income for today's retirees, but recent polls suggest most people believe there will be no money left to pay benefits by the time they're ready to claim them.
The newly released 2020 report from Social Security's trustees likely won't put their minds at ease.
It warns that the trust fund for the retirement benefits program is likely to run dry in 2034. And while the separate trust fund for Social Security Disability is in better shape, the money from it will likely be diverted to support the retirement benefits program. When that happens, the combined trust fund will run short in 2035.
At first glance, this news seems to suggest workers are right to believe no benefits will be available for them. But the reality is that the depletion of the trust fund doesn't mean what most people think it does.
Here's what really happens when the trust fund runs out
The good news is that Social Security's trust fund is not the sole source of money used to pay benefits. In fact, it's not even the primary source. Most of the money comes from payroll taxes collected from current workers and their employers.
Together, employees and the companies they work for each pay half of a 12.4% percent payroll tax used to support Social Security (those who are self-employed pay the entire 12.4%). Payroll taxes are collected on income up to a certain maximum called the wage base limit (it was $137,700 in 2020).
Collectively, these taxes provided $805.1 billion of the $917.9 billion in funding to Social Security in 2019. The rest came from taxes on benefits and interest earned by excess money from the trust fund that was invested in interest-bearing securities.
Payroll taxes won't stop just because the trust fund is depleted -- unless the laws are changed to stop or reduce them. The money from them can be used to continue paying retirement benefits. But it just won't be enough to pay the entire amount due. And that problem will be compounded by an aging population, as there will be more people relying on benefits in the future while the number of working-age people paying into the system drops.
How much would benefits actually be cut if the trust fund runs dry?
If the trust fund runs out of money in 2035 as expected, the revenue coming into the program is expected to be enough to pay about 79% of promised benefits. Without the trust fund to supplement it, that would mean retirees would be looking at a 21% benefits cut.
That's still a huge amount of money, considering that about over a fifth of married couples and almost half of unmarried people get at least 90% of their retirement income from Social Security.
But while it would be bad news if the trust fund runs dry and this happens, it would not mean a complete end to benefits as most people think.
Will the trust fund run dry?
There are a number of options on the table to make Social Security more financially stable. Raising the retirement age, increasing payroll taxes, or lifting the cap on the amount of income that's taxed are all possible options to avoid the depletion of the trust fund and ensure that benefits continue as promised.
It's unclear when lawmakers will act or what approach they'll choose -- but it's also very unlikely politicians from either side of the aisle will allow a 21% benefit cut to hit the elderly in 2035 or at any time in the foreseeable future.
Still, that doesn't mean you shouldn't be concerned. Efforts to prevent this outcome very likely could lead to an increase in the retirement age, which would be a de facto benefits cut since it would mean more people face early filing penalties and fewer opportunities to earn delayed retirement credits.
And even in a best-case scenario where no cuts happen and the retirement age remains unchanged, Social Security doesn't provide adequate income to be your sole source of support. You should always aim to have supplementary savings in a retirement investment account to ensure you have the money to live comfortably as a retiree.