Social Security retirement benefits have become a vital income source for most retirees, despite the fact that the monthly amount isn't very big. With an average benefit of just $1,503 per month in 2020, this money barely keeps retirees above the poverty level unless they have supplementary income.
That's why it's such bad news that benefit cuts are on the horizon if something doesn't change soon. In fact, the most recent report from the Social Security trustees suggests that the combined trust funds supporting retirement, survivors, and disability benefits could run dry in 2035. And there's reason to be concerned the reserve funds will be depleted even sooner, thanks to coronavirus.
If that happens, there'll still be money to pay some portion of benefits since the program will continue collecting payroll taxes. But tax revenue isn't enough to pay out all that has been promised, so a big benefits cut would have to happen unless lawmakers make some changes to the current system. But just how big would that cut be?
The benefits cut would be a painful one
Social Security actually has separate trust funds for retirement benefits and disability benefits. The retirement fund alone is scheduled to run out in 2034, at which time payroll taxes would be enough to pay just 76% of scheduled benefits. That would leave retirees looking at a 24% cut.
The disability fund is in better financial shape, so its likely funds will be diverted from it to stave off cuts to retirement income. Sadly, because this fund is smaller, that would buy beneficiaries only an extra year. In 2035, when the combined trust fund would again be bankrupt, payroll taxes would cover about 79% of promised benefits. That means an across-the-board benefits cut of 21% would still be necessary.
Sadly, this 21% cut to benefits is a bigger reduction than the trustees warned about last year. In 2019, the projected cut to benefits was just 20%. And although 1% may not seem like much, it makes a big difference to retirees who often can't afford to withstand any reduction in Social Security income.
Lawmakers can stop it, but acting quicker would be best
Any cut to Social Security benefits could cause financial devastation for many, much less a cut that reduces monthly income by more than 20%. And there are options available to make sure that doesn't happen. Raising the payroll tax, changing the amount of income subject to the tax, and raising the age at which individuals are eligible for full retirement benefits are some of the most common suggestions for ensuring the trust fund doesn't run dry.
Unfortunately, the amount of extra revenue that would need to be collected each year to keep the system solvent grows the longer politicians don't act. While there's little will to raise taxes now, it will only get harder in the future when the bump in the tax rate would need to be even higher. The longer politicians put off the pain, the more likely it will be that some benefit cuts will happen.
Current and future retirees should prepare for this unpleasant reality, and the best way to do so is to save as much money as possible. If you have supplementary savings, a cut to Social Security benefits wouldn't be nearly as devastating as if you're relying on those benefits for your sole or primary source of support in your later years.