You pay dearly for your promised Social Security benefits. Between your own contribution and your employer's contribution on your behalf, 12.4% of the first $117,000 of your earned income gets sent to Uncle Sam as a tax to pay for that program.
Despite that substantial tax rate, the program is in financial trouble. Its own trustees estimate that by 2033 its trust funds will empty and it will only be able to pay about 77% of expected benefits. Those same trustees estimate that it would take a tax rate of about 17.1% of covered payroll to cover Social Security's costs in 2035, rising to 18.2% by 2088.
What that means to you
In a nutshell, Social Security's trustees are making it abundantly clear that the program is not sustainable as is. Without changes, the already expensive benefits it provides will either become much more expensive to fund or get cut substantially.
Chances are strong that Social Security will survive but will look somewhat different from how it does today. If history is any guide, Congress will likely tinker around the edges with some combination of tax hikes and benefit cuts in order to shore up the system. Here are a few past and proposed adjustments that have affected, or may affect, the program.
Over Social Security's history, total tax rates -- including the employee and employer parts -- have risen from 2% at its inception to the current 12.4%. The earned income subject to Social Security tax has increased as well, to $117,000 from $3,000 when the program began. Even adjusting for inflation, that income cap has more than doubled.
A combination of tax hikes and benefit cuts
In 1984, Social Security benefits became subject to income taxes. Today, up to 85% of your Social Security check can be subject to income taxes if you have sufficient total income levels. A large portion of those taxes go to help shore up Social Security's trust fund, and the rest go to shore up Medicare. In essence, these taxes cut the net benefits received by many Social Security recipients.
While Social Security's benefits are indexed to inflation, there are serious doubts that the inflation gauge used in that index truly measures the higher inflation rate experienced by seniors. Additionally, there's a proposal that surfaces from time to time to use a chain-weighted inflation index to slow that inflation adjustment even further.
What can you do about it?
Remember that even if nothing changes, Social Security is still on track to pay out about 77% of its expected benefits once its trust funds empty. It's the other 23% or so that is primarily at risk. Chances are that the shortfall will be covered by some combination of tax hikes and benefit cuts, as it has so many other times in the past when Social Security was at risk of not meeting its obligations.
With that as the backdrop, you should figure out how to invest your money now to cover the cost of the next patch when it does get implemented. After all:
- If tax rates go up, it's a lot easier to cut back on investing to cover those taxes than it is to cut back on your living expenses in response to a tax hike.
- If benefits get cut, it's a lot better to draw money from your nest egg than it is to be forced to cut your living expenses in response to a benefit cut.
- If some other solution is found that doesn't either raise taxes or cut benefits, then the money you save by preparing for those other outcomes remains yours to enjoy.
The thing about investing, though, is that the more time you put into it, the better your odds of success. You still have about 19 years before the Social Security trust funds are expected to empty. Get started now, and you'll substantially improve your prospects.