If it weren't for Social Security, perhaps more working Americans would be motivated to save for retirement on their own. But it's easy enough to let retirement plan contributions fall by the wayside when there's the promise of benefit payments for life once you reach a certain age.
If you've been reading up on Social Security, though, you may have heard that the program may be looking at sweeping benefit cuts in less than a decade from now. And that should motivate you to save for retirement on your own rather than simply fall back on Social Security.
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But benefit cuts actually aren't the main reason you shouldn't count too much on Social Security. There's another big issue with Social Security that far too many people don't know about.
Your monthly benefits won't cut it -- even if they aren't reduced
Even though Social Security is facing the possibility of benefit cuts right now, it's important to recognize that they are not a given. Lawmakers have faced Social Security cuts in the past and successfully prevented them. It's possible the same thing will happen this time around, too.
However, even if Social Security benefits aren't slashed broadly, that doesn't solve the fact that they'll only replace a limited portion of your pre-retirement income. A lot of people don't realize this and wind up struggling financially as a result.
If you earn an average paycheck, you can expect Social Security to take the place of about 40% of it once you retire. But that means you'll be facing a 60% pay cut, which, frankly, is huge.
Think about the bills you have today, and then try to figure out if any of them will be considerably lower in retirement. You may be able to shed the cost of a commute to work, and your mortgage may be paid off. But other than those two expenses, you may find that most of your bills don't shrink.
Now, go ahead and add up your mortgage payment and commuting costs. Do those two expenses amount to 60% of your income? Chances are, no.
And this illustrates perfectly why counting on Social Security to cover your retirement bills is not a smart move. You can, of course, use those benefits to supplement other income. But they definitely should not be your only source.
How to build a retirement nest egg painlessly
Of course, the challenge of saving for retirement is finding a way to free up money for your IRA or 401(k) plan without having to limit yourself financially. To that end, your best bet is to give yourself as long a savings window as possible.
If you give yourself 35 or 40 years to build a retirement nest egg, you won't have to part with as much money on a monthly basis as you would by starting to save later on. And if you invest your savings wisely, your portfolio can also do some of the heavy lifting.
Here's an example. You start contributing $300 a month to an IRA at age 25. You pledge not to touch that money until age 67, which is full retirement age for Social Security purposes.
If your portfolio gives you an average annual 8% return, which is a bit below the stock market's average, then in 42 years, you could be sitting on close to $1.1 million. That's a nice amount of money to kick off retirement with.
But now watch what happens if you start saving that $300 a month at age 35 instead of 25. All other things being equal, you're looking at a nest egg worth about $483,000.
That's certainly a lot of money, too. But it's a far cry from $1.1 million.
Make sure you have a plan
It's too soon to know whether Social Security cuts will actually happen. But regardless of whether they do or not, the fact of the matter is that you probably can't afford to retire on Social Security alone. The sooner you realize that and begin building savings, the more likely you'll be to have a financially stable and rewarding retirement.
