Author: Sean Williams | November 07, 2018
This financial rock could turn into a deadweight if you’re not careful
For nearly eight decades, Social Security has been a financial rock for retirees. Designed as a program to provide benefits for older Americans who no longer could provide on their own, it’s responsible today for keeping more than 15 million aged beneficiaries above the federal poverty line.
But you have to understand, there’s a fine line between counting on Social Security to help you out in retirement and expecting Social Security to do most of the heavy lifting. Of the more than 43 million retired workers receiving a Social Security check as of September, 62% were relying on their payout to account for at least half of their monthly income. Further, 34% are leaning on the program for virtually all of their income (90%-plus).
You might be under the impression that there’s no harm in relying on Social Security to be your primary income source during your golden years, but it’s actually a very bad idea for the following five reasons.
1. It’s not that big of a monthly payout
For starters, Social Security isn’t designed to be a primary income source -- at least not according to the Social Security Administration (SSA). The official guideline from the SSA is that the average retired worker should expect the program to replace about 40% of their working wages. This percentage could be a tad higher for workers with a lower lifetime average income, or perhaps a bit lower for the well-to-do. The point being, it shouldn’t be anywhere near the 90%-plus that roughly a third of today’s retired workers are leaning on.
Your Social Security benefit also isn’t going to make you rich, or necessarily allow you to make ends meet comfortably, depending on where you live. In September 2018, the average retired worker was receiving $1,417.22 a month, or approximately $17,000 a year. If you’re retired in a high-cost state like California or New York, $17,000 in annual income won’t stretch very far.
Plus, benefits are capped at the other end of the spectrum. In 2018, the SSA will pay out a maximum of $2,788 in monthly benefits at full retirement age (i.e., the age at which you qualify to receive your full benefit, as determined by your birth year). Whether you made $150,000 a year or $50 million a year throughout your lifetime, $2,788 a month is the maximum benefit at full retirement age this year.
Social Security income simply don’t stretch that far.
2. Your benefit could be cut in less than two decades
To make matters worse, the Social Security benefit of current and future retirees could be just 16 years away from being cut.
According to the latest annual report from the Social Security Board of Trustees, the program is set to undergo a major change this year. Namely, it’ll expend more than it collects in revenue for the first time since 1982. Although we’re only talking about a net cash outflow of $1.7 billion, which is peanuts next to the $2.89 trillion currently in the Trust’s asset reserves, this outflow is expected to rapidly accelerate in 2020 and beyond. By the time 2034 rolls around, all $2.89 trillion in excess cash is projected to be exhausted.
In layman’s terms, this net cash outflow shows that the current payout schedule isn’t sustainable. There’s simply not enough revenue being collected to support current benefits beyond 2034. The Trustees report estimates that an across-the-board cut to benefits of 21% may be necessary to ensure payouts continue through 2092.
Put into another context, we’re talking about chopping the average monthly benefit from $1,417.22 to $1,119.60, in 2018 dollars.
3. Your monthly check will almost certainly continue losing purchasing power
Another reason relying heavily on Social Security isn’t such a good idea is the precipitous loss of Social Security’s purchasing power over time.
The Senior Citizens League, a nonpartisan group aiming to advance issues important to senior citizens, conducted an analysis earlier this year and found that the purchasing power of Social Security dollars has declined by a whopping 34% since the year 2000. In other words, what $100 in Social Security income purchased in goods and services in 2000, now buys $66 worth of those same goods and services.
In theory, Social Security’s inflationary tether, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), is supposed to perfectly take into account the inflation that beneficiaries face, thereby passing along a commensurate raise (known officially as a cost-of-living adjustment, or COLA) the following year. But the CPI-W is inherently flawed.
As the name implies, it tracks the spending habits of “urban wage earners and clerical workers” who aren’t typically aged 62 and up, or receiving a Social Security benefit. And, as you probably surmised, urban and clerical workers spend their money differently than senior citizens. As a percentage of total expenditures, clerical and urban workers spend less on medical care and housing, which are important expenses for seniors. Likewise, lesser-important categories like education, transportation, and entertainment, are given more weight. Ultimately, it results in seniors not receiving an accurate annual COLA and, therefore, losing out to inflation more years than not.
4. You’ll never know your exact monthly benefit until you hit eligible claiming age
Relying on Social Security can also expose you to a lot of unknowns, such as not knowing exactly what your full retirement benefit will be until you’ve reached the eligible claiming age.
Your retirement benefit is based on four primary factors:
- Your work history
- Your earnings history
- Your birth year
- Your claiming age
When you’re in your 20s and 30s, you can do no better than guess what you’ll be earning in your 40s and 50s. This makes projecting your full retirement benefit no more than an educated guess -- and that’s worrisome if you’re planning to lean on Social Security as your primary income source.
Furthermore, factors beyond your control could impact your payout. Data from the SSA shows that more than a quarter of today’s 20-year-olds will become disabled prior to reaching their full retirement age (age 67, for those born in 1960 or later). Additionally, you can’t control when you get sick or what ailment(s) you contract, which makes it difficult to know how long you’ll be able to work.
These unknowns make a comfortable retirement far from a guarantee.
5. It could steer you away from saving and investing for your future
Last, but certainly not least, if you’re planning to rely on Social Security income during retirement, it may cause you to neglect saving and investing for your future.
As noted, Social Security benefits aren’t very predictable until you’re a senior, they could be cut over the next 16 years, and they’re liable to lose purchasing power to inflation over time. Comparatively, money invested in the stock market has grown at a historical rate of 7% per year, inclusive of dividends and when adjusted for inflation. While this isn’t to say that all of your money needs to be invested in the stock market, it suggests that having at least some exposure to equity investing is a good thing, since it’s one of the few assets to continually trounce inflation over the long run.
In short, you’ll want to be careful not to use the guaranteed income that Social Security can provide to eligible beneficiaries as an excuse to put off saving and investing.
The silver lining for seniors: Social Security isn’t going anywhere
But, if there is a silver lining to all of this seemingly bad news, it’s that Social Security is here to stay.
Even if Congress fails to raise any additional revenue and the program exhausts its nearly $2.9 trillion in asset reserves, it has two built-in sources of recurring income that’ll ensure eligible beneficiaries continue to see a monthly check.
First, there’s the 12.4% payroll tax on earned income up to $128,400, as of 2018. Last year, more than 87% of the $996.6 billion collected by Social Security was generated from its payroll tax. As long as Americans keep working, and Congress doesn’t change how the program is funded, the payroll tax will almost singlehandedly keep payouts flowing.
The other recurring source of revenue is the taxation of benefits. Signed into law in 1983 and implemented the following year, the taxation of benefits allows the federal government to tax a portion of Social Security income for households above certain income thresholds.
Together, these recurring sources of revenue combined for more than 91% of what was collected in 2017. Even without a single red cent in excess cash, Social Security is designed to survive for a very long time.
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