Social Security has a serious problem on its hands.
The program, which began paying out benefits more than 75 years ago and is primarily designed to provide income to low-wage workers in retirement, is facing an expected cash reserve shortfall in less than 20 years according to the most recent report from the Social Security Board of Trustees.
Two demographic shifts are primarily responsible for this impending cash shortfall.
For starters, we have baby boomers retiring in increasing numbers each year. As these labor force workers transition into Social Security beneficiaries, the number of workers paying into the program relative to beneficiaries receiving benefits from the program will fall. By 2035 the Board of Trustees anticipates that a persistent cash outflow will have depleted all excess cash reserves.
The other issue ties into longer life expectancies. The average retiree at age 60 these days is going to live another two decades or longer. Data from the Centers for Disease Control and Prevention also shows that average life expectancies are up nine years over the past five decades. Long story short, retirees have been able to draw benefits for a longer period of time, resulting in an exacerbated expected decline of the Social Security Trust's cash reserves.
Two reasons why Social Security shouldn't be your primary source of income
Yet the bigger concern might be how many pre-retirees are planning to lean heavily on Social Security during retirement. The Social Security Administration guides folks to expect benefits from the program to replace about 40% of their working wages. Yet an AARP survey of pre-retirees ages 45 to 64 shows that 51% plan to rely on Social Security benefits for 41% to 100% of their income during retirement. This included 3-in-10 who planned to rely on Social Security for 61% or more of their retirement income.
This is worrisome, because relying on Social Security income during your retirement could leave you struggling financially.
1. Benefit cuts are a real possibility
The first problem is that there's no clear path to fixing Social Security. While there have been well over a dozen proposals offered up throughout the years, none are completely without drawbacks. Some popular solutions have included removing the payroll earnings tax cap and taxing the rich at a higher rate or raising the retirement age. Though both suggestions do indeed help curb the cash shortfall, these two suggestions only cover about half of the projected cash shortage. Furthermore, they come with some aforementioned drawbacks that might make them less favorable long-term solutions.
When glossing over the possible fixes for Social Security, the few that appear able to fix the program's cash shortfall are among its least popular. These include tax increases and/or benefit cuts. Yet the thing about benefit cuts is that they get the job done and preserve the solvency of the Social Security program for another 50-plus years. The threat of cuts could also light a fire under current workers to do more to save and invest on their own, as well as work longer if possible.
What sort of cuts are we looking at? How about a 21% across-the-board reduction to keep the program solvent through 2087. Do you really want to head into retirement with a possible 21% benefits cut hanging over your head?
2. You could lose buying power
The other often-overlooked concern with leaning too heavily on Social Security is that your benefits could lose "buying power" over time.
The Social Security Administration tries to fix this by tying benefits to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W takes into account the rising costs for a number of goods and services and helps the SSA determine what sort of inflationary increase (if any) to pass along to beneficiaries in the upcoming year. Because inflation rates were essentially negligible in recent months, beneficiaries received no increase in benefits in 2016. Nonetheless, in theory, benefits should rise in step with inflation... or so it seems.
Out of the roughly 60 million current beneficiaries, however, two-thirds are retired workers. Retirees often have far different expenses than urban wage workers and clerical workers. An inflationary measure that more accurately reflects what seniors are spending their money on, but which is currently not being used to determine Social Security benefits, is the CPI-E, or Consumer Price Index for the Elderly. The CPI-E provides added weight to housing and medical costs relative to the CPI-W, which tends to put added emphasis on transportation, education, apparel, and food.
In short, seniors could find that their Social Security benefits aren't enough to cover expenses such as medical costs, which are handily outpacing the rate of inflation. If you're relying heavily on Social Security income, your ability to receive and pay for medical care could be compromised.
Change your mode of thinking
While Social Security will indeed be there for you when you retire, you'll need to have ample income from other sources beyond just this entitlement program. This means formulating a budget and saving as efficiently as possible, investing for your future and allowing time and compounding to do the work for you, planning your investment strategy before and after retirement to minimize how much you'll hand back in taxes, and having a withdrawal plan to ensure your nest egg lasts beyond your lifetime.
Social Security benefits should just be the gravy on your mashed potatoes and not the main course. Take the time to change your trajectory if you're among the 51% of pre-retirees planning to lean heavily on the program in retirement.