Social Security’s trustees on Aug. 31 issued another somber annual report that, as in previous years, warned of the pending depletion of reserves. The current projection is that the trust fund backing retirement benefits only will run out of money by 2033, a year earlier than estimated in the 2020 report.
It’s another wake-up call that Congress needs to do something — and the sooner the better. It’s also a reminder that individuals may want to prepare more on their own. But the latest report doesn’t say the system is going broke and will be unable to pay any benefits in a dozen-plus years.
Here are answers to questions regarding Social Security’s retirement financing, where it’s headed, and what it means for the 93% of Americans tied into the system.
What’s the report’s key takeaway?
Media reports have focused on the pending depletion of the trust fund supporting Social Security retirement benefits. This OASI fund, for Old-Age & Survivors Insurance, is now projected to run out of money in 2033. If including disability benefits, the DI fund, the system could be insolvent by 2034.
What does insolvency mean?
In the context of Social Security, insolvency means the trust-fund financial cushion is expected to be exhausted by 2033. It doesn’t mean the system will stop paying benefits entirely around that time.
Even without this cushion, Social Security will still collect payroll and self-employment taxes and even income taxes (some higher earners face taxes on a portion of their benefits). Still, all this portends a cut in benefits, an increase in taxes or other actions to get the system’s cash flow back to equilibrium.
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So there are two key components?
Yes. Think of Social Security’s retirement system as having a checking account and a savings account. The checking account receives all that payroll tax and other income and is constantly doling out benefits and paying other expenses. In years when income is comparatively low, it taps into the savings account, the trust fund, to pay benefits in full. Unfortunately, the Social Security system, like many Americans, has leaned heavily on savings withdrawals lately, and this cushion could run dry by 2033.
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Is the 2033 projection unusually soon?
Not really. For nearly the past decade, Social Security’s trustees have warned that the retirement trust fund would be depleted in either 2034 or 2035 (the years bounce around). In the 1997 trustee’s report, the depletion year was as early as 2031. In certain other reports, it was projected to come much later, after 2050.
Still, the current trend is worrisome, especially as the big baby boomer generation is retiring en masse and only 2.7 workers now support each beneficiary, with the ratio decreasing. Besides, the depletion scenario is now just 12 years away.
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Can Congress fix things?
Yes, as it has done several times in the past. Most of these remedies involve higher payroll taxes, benefit cuts or a combination. Higher taxes could spread across the board or focus on higher earners, for example. Benefit cuts also could be applied across the board or target high earners. There are options, but time is running out.
“Taking action sooner rather than later will permit consideration of a broader range of solutions and provide more time to phase in changes so that the public has adequate time to report,” the trustees said in their latest report.
Yet in today’s highly politicized environment, Congressional action doesn’t seem imminent.
How deep might the cuts be?
The current estimate is for a reduction of about $1 for every $4 or so in benefits starting in 2033. “At that time, the fund’s reserves will become depleted and continuing tax income will be sufficient to pay 76% of scheduled benefits,” the trustees said.
Another way to look at it is by examining how much of a typical retiree’s income will be paid or replaced by Social Security benefits. Pensions, personal savings, perhaps housing equity and other assets make up the rest.
Lower-income people who are more dependent on the program could get hurt worse. On average, they currently rely on Social Security to replace about 56% of what their preretirement income was. That might fall to around 44% with across-the-board cuts, according to a Congressional Research Service analysis. Higher-income earners rely on Social Security to replace 35% of income, and that might fall to around 27%.
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What actions might individuals take?
People have many options to shore up their personal finances to make them less reliant on Social Security. The whole field of retirement planning is tied, at least partly, to generating enough income to support a standard of living beyond what Social Security provides. The system was never intended to cover all of your retirement needs. The typical payment to retirees is just a bit above $1,500 a month.
So what can you do? Start saving more, now. Utilize tax-sheltered retirement accounts such as workplace 401(k) plans and Individual Retirement Accounts. Pare down debt, especially that with high interest rates (credit cards), that taken on depreciating assets (cars and trucks) or that incurred for other people’s benefit (a child’s higher education).
What other actions can you take?
There are many more possibilities. For example, if your income is low, take a look at the Retirement Saver’s Credit, which provides a modest government retirement match, worth up to $1,000 per person, in the form of a tax credit. If you have access to a Health Savings Account at work, start contributing money. These accounts offer a tax deduction upfront, while withdrawals can be taken tax-free for health costs in retirement.
If you’re already in good shape, with ample money in IRAs or a 401(k) plan, devise a withdrawal strategy, taking Required Minimum Distributions into account, so that you minimize taxes and avoid a tax bill on some of your Social Security benefits.
What about delaying Social Security?
This is the biggest decision most people need to make about participating in the program. You can elect to start claiming retirement benefits as early as age 62 or as late as 70. For each year you wait, your monthly benefit amount rises.
The argument for claiming early is to collect benefits for a longer period, especially when the gettin’s good (before any cuts). Perhaps you also need the income from Social Security to make ends meet now.
The key argument for delaying is that you will lock in higher monthly benefits that can help you avoid running out of money in old age. Keep in mind, also, that future COLAs or cost-of-living adjustments will get tacked onto larger benefits. Longevity risk explains why many, if not most, financial experts favor delaying for as long as you can.
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