The Social Security program will probably go through some serious changes over the next decade, and it could have major impacts on retirement planning. It's important to understand how your Social Security benefits might change, and what that means for your retirement account. There are important steps that everyone can take so that they don't even have to worry about the status of federal retirement benefits.
The problem with Social Security
First, don't panic, thinking that Social Security is going to run out of money and disappear. Government officials and lawmakers are aware of the program's pending shortfalls, so I'm confident that they'll have the time and ability to make adjustments.
Image source: Getty Images.
That said, significant changes need to be made. In 2021, the fund paid out more than it received for the first time since the 1980s, so it's entered the cash-burning phase. Under the current projections, the Social Security Trust will run out of money between 2032 and 2035, according to analysis by the Congressional Budget Office and external organizations.
The fund's cumulative deficit is expected to be $2.5 trillion over the next decade. As the aging population swells and workforce participation declines, this problem is only getting worse. The ratio of contributors to beneficiaries isn't sustainable, as the chart shows.
Data source: St. Louis Fed and U.S. Bureau of Labor Statistics.
Where is Social Security heading?
Legislators will be faced with tough decisions and negotiations about how to fix the situation and extend Social Security's life span. The most likely outcome will result in a combination of reduced benefits for future retirees, along with higher taxes on current earners.
I'm not buying into the most extreme variety of hysteria and expecting my Social Security benefits to be zero. However, I am fairly confident that today's recipients are enjoying more buying power with those benefits than people who retire at least 20 years from now. I'm treating it like an unknown that's certain to contribute less cash flow in retirement.
It's not as if Social Security payouts are enormous today, either. The current average monthly benefit is around $1,800, while the maximum benefit for people reaching full retirement age in 2023 is $3,627. These are significant numbers for most households, but many people aspire to a lifestyle that requires much higher cash flow.
Making up for lower Social Security benefits
To reach our financial goals, most of us will have to build assets throughout our working lives so that we can turn them into income throughout retirement. This requires a quantifiable savings strategy, discipline, and a plan for distributing savings.
The first step is achieving and maintaining a high savings rate. Most households should strive to save 15% to 20% of their net income -- it might need to be on the higher side to make up for a drop in Social Security benefits.
To increase your savings rate, it's important to create a budget and track where your income goes each month. That way, you can measure progress. It might be helpful to set aside a predetermined amount of each paycheck that can systematically feed a savings or investment account. It's also helpful to utilize retirement accounts and employer contribution matches to ensure you're saving a decent amount before it even hits your paycheck.
As you accumulate assets, they need to be invested for responsible growth. I'm still at least 30 years away from retirement, so my priority is generating the highest possible returns within my risk tolerance. I'll pay more attention to reducing volatility -- and limiting losses -- with bonds and dividend stocks as I approach retirement.
For now, I'm focused on a retirement investment portfolio with relatively high exposure to growth stocks and quality factors, supported by a smaller allocation to value stocks. Your portfolio allocation should evolve as your retirement investment timeline changes. This is likely to provide the highest possible long-term returns.
Distribution is the final phase of retirement planning, and it's an important consideration if you don't want to depend on Social Security. After you stop working, you'll have to rely on your accumulated assets to provide cash to cover basic needs and lifestyle expenses. Financial planners have generally followed the 4% rule, which asserts that retirees can spend no more than 4% of their investment account each year. Any more than that, and they run the risk of outliving their savings.
This is an important consideration that many people don't realize. Everyone can have their own retirement income goals, but you'll have to build enough liquid wealth to satisfy the 4% rule. If you want $50,000 in annual distributions from an investment account in retirement, you need at least $1.25 million in that account. That's $2.5 million if you want $100,000 in retirement income each year.
Make sure that your goal setting reflects these distribution principles -- it could have major implications for the age that you're able to retire.
