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3 Reasons Social Security Won't Cover Your Retirement

By Chuck Saletta - Jan 24, 2015 at 6:00PM

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It's not designed to, its trust funds are running out of money, and demographics are shifting against its funding model.

Source: FBI.

One of the most financially dangerous mistakes you can make is to assume that because you'll get Social Security, you won't need anything else to cover your retirement. It's particularly dangerous because if you don't realize that mistake until you're ready to start collecting, it's too late to do much about it.

Social Security plays an incredibly important role in the retirement plans of millions of Americans -- and by all accounts, it will still be there in some form when you're eligible to collect. Still, as important as it is, the odds are high that it simply won't be enough to fund your retirement by itself. Here are three key reasons why.

No. 1: Social Security is not designed to be your only source of retirement income
Even assuming Social Security remains perfectly solvent, its benefit calculation is not designed to provide you much more than a buffer against abject poverty in your old age. Here's what Social Security itself says on the matter:

Most financial advisors say you'll need about 70 percent of your pre-retirement earnings to comfortably maintain your pre-retirement standard of living. If you have average earnings, your Social Security retirement benefits will replace only about 40 percent. The percentage is lower for people in the upper income brackets and higher for people with low incomes. You'll need to supplement your benefits with a pension, savings or investments. 

The average retiree currently receives about $1,328 per month from Social Security, and the maximum you could get if you retired today at your full retirement age would be $2,663 per month. To get that highest benefit level, you would have had to reach Social Security's maximum covered earnings for at least 35 years of your career. In 2015, the maximum covered earnings level is $118,500, or $9,875 per month.

No. 2: Social Security's Trust Funds are emptying, which may cause benefits to be cut by 23%
Every year, Social Security's Trustees provide an update on the health of the program. For the past few years, the story has been the same: The trust funds will empty around 2033, and when that happens, benefits will be cut substantially. If no changes are made before then, benefits will be cut immediately by about 23%, and over time, the total cut will be as large as 28%. The chart below from the 2014 Social Security Trustee's report shows the details:

Source: Social Security 2014 Trustees Report.

In other words, the $1,328 that a typical retiree receives today would become the inflation-adjusted equivalent of $1,022.56 per month in 2033, once the Trust Funds empty. Of course, Congress may patch the program as it has several times in the past. Even then, the patches have generally consisted of some combination of tax hikes or benefit cuts, which suggests you'll likely pay for those fixes as a taxpayer, a recipient, or both.

No 3: The demographic tides are shifting against Social Security's funding model
Social Security is a "pay as you go" system in which your taxes pay for current recipients' benefits. That works fairly well so long as there are enough people paying into the system to cover the costs of those receiving benefits. But as the population ages and a smaller portion of the population participates in the workforce, Social Security's funding source is becoming stretched. Per the chart below, Social Security's Trustees expect the ratio to be two workers for every beneficiary in the not too distant future:

Source: Social Security 2014 Trustees Report.

Right now, with a worker-to-beneficiary ratio of about 3-to-1 and a tax rate of 12.4%, Social Security is already paying out more in benefits than it is taking in as taxes. As the worker-to-beneficiary ratio drops precipitously, rates would have to increase substantially just to maintain current benefit levels. That may or may not be a politically feasible option for lawmakers, but it would certainly make it more difficult for future workers to save enough to cover the retirement expenses that Social Security won't.

What can you do about it?
No matter what happens to Social Security in the future, the reality has always been that if you want a comfortable retirement, you need to save above and beyond what you expect from it. If you're already doing that, then you're well on your way toward covering the additional gaps anticipated when the Trust Funds empty. By adding a little bit to your investments, aiming for a slightly higher return, or saving for a few extra years, you can cover that incremental gap with little trouble.

If you haven't yet started saving, there's no time like now to get started. The sooner you get started, the cheaper and easier it will be to cover those gaps between what Social Security will pay and what you'll need for the retirement you're hoping to have.

Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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