Long touted as a program that would ensure the “American Dream,” the Social Security system – one of the critical achievements of President Franklin D. Roosevelt – was created in 1935 to promote economic security. Just a few years later, its very first recipient, a retired legal secretary in Vermont, received her first benefit check on January 31, 1940, for $22.54.
Over the last several decades, the system and its rules have evolved. Still, Social Security pays out hundreds of billions of dollars each year and serves over 70 million people (in 2022).
And while Social Security should be part of your retirement plan, it should not be your whole plan. You may have heard of the “three-legged stool,” a metaphor used to describe the most common sources of retirement income: Social Security, private pensions, and personal savings. Each of these approaches is crucial in ensuring a stable and secure income in retirement. That’s because Social Security might be a great supplementary source of retirement income, but it might not be enough to sustain your finances on its own. Instead, consider it a bridge between a gap in your other retirement savings and any unexpected expenses accrued.
By now, you’ve probably seen the alarming news headlines about the Social Security System running out of money by 2034. And we can understand the anxiety and frustration those headlines can bring to even the most financially prepared people.
You’re probably wondering, then, exactly how secure is Social Security?
First, What is Social Security, and How is it Funded?
Understanding the program and how it might fit into your retirement plan is crucial, no matter how prudent your retirement savings plan is or how far from retirement you are.
Nearing its 83rd birthday, Social Security is an insurance program that provides retirement benefits and disability income to qualified people and their spouses, children, and survivors. Workers must pay into the program through payroll taxes their employer withholds (these taxes are also paid by self-employed workers when they file their federal tax returns).
To receive monthly benefits, you must be 62 years old (currently, but this number may change in the future) and have paid into the system for at least ten years. Your benefit amount is calculated based on your average indexed monthly earnings (AIME) over your 35 highest-earning years, so this number will vary between people.
It’s worth pointing out that Social Security is not a savings plan. What you pay into the system is not set aside with your name on it. Instead, all Social Security taxes are collected into the Social Security pot – or two trust funds – the Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI). The former covers the benefits for retirees, spouses, and survivors, and the latter covers disability benefits. In 2021, those taxes accounted for about 90 percent of Social Security’s revenue of $981 billion. The remainder of the revenue comes from these sources:
- $70.1 billion from interest on money invested in federally-backed guaranteed securities
- $37.6 billion from income taxes paid on Social Security benefits (based on your qualifications, you might pay taxes on up to 85% of your Social Security income)
- Less than $50 million from reimbursements from the U.S. Treasury
For much of its existence, Social Security has generally taken in more money than it has paid, generating a relatively large reserve – around $2.85 trillion at the end of 2021. However, as more and more baby boomers retire, that trend of net gains has been reversing.
Will Baby Boomers Bankrupt Social Security?
Well, not exactly. Even though the latest annual report by the Social Security Board of Trustees shows a depletion of the reserves by 2035, that doesn’t mean Social Security is just going broke. Even if the funds are exhausted, the program can continue paying out benefits from its annual tax revenue. Based on current projections, these payments might be about 80 percent of what beneficiaries would expect to collect and could continue to decline.
Without congressional action to safeguard its future, Social Security – an essential source of income for millions of retirees – will exist after 2034, but retirees may see less and less of the benefits they’re counting on.
The cohort, born between 1946 and 1964, first qualified for Social Security benefits in 2008. So by 2031, there will be 75 million baby boomers over 65. But their life expectancy, more than their size, could really affect the distribution of the benefits. At the origination of Social Security, people aged 65 were expected to live an additional 12.5 years. Today, men and women are expected to live 19.1 and 21.7 years, respectively, past 65 – excellent news for us but potentially problematic for the Social Security surplus!
So, What Happens Now, and Will My Future Benefits be Protected?
Since it acts as a pay-as-you-go system, Social Security will not run out of money as long as workers and employers continue contributing to payroll taxes. However, it won’t be without funding challenges. Since Social Security has begun to pay out more than it collects as the retiree population grows, steps should be taken to shore up its financial future.
Currently, several proposed changes are on the table to ensure your benefits are protected. These include raising the full retirement age, increasing the payroll tax rate, or lowering benefits.
As we await more information on the fate of Social Security, we should remain focused on the goals of our retirement plan, continuing to build the other two legs on our stool. Save as much as possible and invest whatever you can, regardless of the Social Security benefits that might be waiting when you retire.
And in addition to working with a trusted advisor, there are valuable resources like AARP and the Social Security Administration that can walk you through everything you need to know about the program. If you’re not yet working with a Financial Advisor, go ahead and schedule a complimentary call where we can help answer your questions about achieving financial security in retirement!
