Many people wind up looking to Social Security as their primary source of retirement income. And those who go this route often end up cash-strapped and forced to cut corners.
Now it's perfectly OK to factor in Social Security as a viable source of retirement income. But it shouldn't be your main source -- largely because your benefits might end up amounting to less than you'd expect. Here's why.
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1. Benefit cuts could come into play in a little over a decade
Social Security is facing a massive revenue shortfall. In the coming years, it expects to owe more in scheduled benefits than it takes in.
Social Security can tap its trust funds to keep up with scheduled benefits until its cash reserves run dry. But according to the program's latest Trustees report, that's expected to happen as early as 2034. And from there, benefit cuts are a big possibility -- one that might lead to a lower payday from Social Security for you.
2. Benefits can be taxed
Many seniors are surprised to learn that Social Security benefits have the potential to be taxable. First, there are 12 states that tax benefits to varying degrees (though lower- and even moderate-income seniors may be eligible for an exemption in some states). But also, your benefits may be subject to federal taxes if you have other income at your disposal.
Whether you'll pay taxes on Social Security will hinge on your provisional income. That's half of your annual benefit plus your non-Social Security income (including tax-free interest income you might earn from an investment like municipal bonds, but not including tax-free withdrawals from a Roth IRA).
If your provisional income hits $25,000 and you're single, or $32,000 and you're married, federal taxes on your benefits will apply. Clearly, these aren't very large thresholds, so your chances of being taxed on Social Security aren't so slim.
3. You may be forced to claim benefits early
Many people plan to work well into their 60s, only to find themselves out of a job earlier in life, whether due to health issues or layoffs. If you're forced to claim Social Security before reaching full retirement age (which is 67 if you were born in 1960 or later), you might lose out on benefits by virtue of having to take them early.
Don't set yourself up for a financially stressful retirement
Many people end up depending heavily on Social Security in retirement. But it's important to build savings in case your benefits come in lower than expected.
The good news is that you don't necessarily have to part with a ton of your income to accumulate a respectable nest egg. If you were to sock away $300 a month in an IRA or 401(k) plan over 40 years and invest your savings at an average annual 8% return, which is a bit below the stock market's average, you'd wind up with a balance of almost $933,000. That gives you a nice cushion in case the monthly benefit you end up collecting from Social Security ultimately disappoints you.
