Source: Flickr user Eric Chan.

In its most recent trustees' report, the Social Security Administration warned that Social Security's trust funds would run out of money by 2033. When the trust funds empty, Social Security expects it will only be able to pay out about 77% of expected benefits, leaving the other 23% at risk.

While many factors are contributing to that decline, one factor matters more than any others: demographics. Social Security is a "pay as you go" system, and the number of people working and paying taxes to support the system continues to shrink relative to the number of people collecting from it. As life expectancies increase and birth rates fall, that imbalance will only get worse.

How bad can it be?
The chart below shows the ratio of covered workers (people earning money and paying Social Security taxes) to beneficiaries (people receiving Social Security benefits) and its trend over time. Note the substantial decline since the 1950s -- and the expected continuation of that decline from the current level of three-to-one to around two-to-one as time progresses:

Source: Social Security. 

That demographic reality, combined with Social Security's pay-as-you-go structure, makes its challenges structural ones not easily resolved. Indeed, Social Security's trustees estimate that over time, absent any structural changes to the program, a tax rate of 18.19% of covered payroll would be needed just to cover current anticipated benefits, versus the current rate of 12.4%.

What you can do about it
First, understand that the demographic reality of the U.S. makes changes to Social Security inevitable. Benefits will get cut, taxes will increase, or the program will need to shift from a pay-as-you-go, defined-benefit model to a 401(k)-style defined-contribution model with no guaranteed payments. Of those options, history and the conversion costs of moving to a defined-contribution plan suggest that some combination of tax hikes and benefit cuts are what will likely make it through Congress.

Next, consider that no matter what the next round of fixes brings to Social Security, your best option for handling the transition is to start saving and investing now. Here's why:

  • If tax rates go up, it will be a lot easier to reduce your savings rate to cover the higher taxes than it will be to cut your costs of living to cover those taxes.
  • If benefits get cut, the money you will have saved between now and then can go a long way toward covering the gap between what you anticipated to get from Social Security and what Social Security actually provides.
  • If Social Security converts to a defined-contribution plan, then you'll have experience managing your own investments and can start building a financial buffer against the uncertainty inherent in a plan that won't guarantee a specific income level.

How much will you need?
Your expected Social Security benefit is based largely on your (or your spouse's) earnings history and the age at which you start taking payments. On average, Social Security expects that a typical retiree's payment will be $1,328 per month in January 2015, after its inflation adjustment gets incorporated. If around 23% of the typical payment is at risk once the trust funds empty, the average Social Security recipient will need to cover the inflation-adjusted equivalent of around $305.44 per month.

There's a rule of thumb in retirement planning known as the 4% rule. This rule suggests that you can spend 4% of a diversified portfolio in your first year of retirement, adjust that amount based on inflation every year, and have a great chance of not running out of money in retirement. Using that rule as a guide, you'd need around $91,632 in today's dollars just to cover the typical Social Security shortfall when the program's trust funds empty.

If you don't have that kind of money, you still have time to get there. After all, the Social Security Trust Funds aren't expected to empty until around 2033. While Congress may move sooner than that to shore up Social Security -- likely via tax hikes or benefit cuts -- the sooner you get started, the easier it will be to get your own buffer in place. And the sooner you get started, the less you'll have to sock away each month to get there.

Take control of your retirement
Even before considering the substantial demographic risks facing your future Social Security benefits, the program was never designed to be more than just a part of your retirement funding. If you already have a decent retirement plan in place, then the risks facing your Social Security benefits should be easy enough to manage within the context of that plan.

If you haven't started your end-to-end planning yet, then take these risks to Social Security as a prompt to get your plan in place. You still have time to put the "gold" in your golden years, and the sooner you start, the better your odds of success.