Could You Cope With a 21% Cut to Your Retirement Income?

By Markets Fool.com

According to a number of studies, the retirement outlook for most Americans is pretty bleak. The latest study, from GoBankingRates, questioned Americans across the country, including both working and retired people, on how much they'd saved for retirement. Keeping in mind that Americans generally have poor personal savings habits to begin with relative to other developed countries, the results were still an eye-opener, and for all the wrong reasons.

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According to GoBankingRates, which offered respondents seven ranges to select from when answering how much they'd saved for retirement, just around a quarter (26%) had in excess of $100,000, while 56% had less than $10,000 saved. What's more, a full third (33%) of respondents hadn't saved a dime toward their retirement. Given this data, it's no wonder that, according to Gallup, 59% of today's retirees count on Social Security to be a major source of income, and per the Insured Retirement Institute, 59% of baby boomers expecting to soon retire are also expecting Social Security to be their primary income source during their golden years.

Relying on Social Security could be a problem

But seniors and baby boomers expecting to rely on Social Security for the bulk of their retirement income could be in for a rude awakening. According to the 2015 Board of Trustees report, the Old-Age, Survivors and Disability Insurance Trust is slated to run out of its excess cash reserves by 2034.

The funds for the Social Security Administration's OASDI payments to seniors comes from a combination of payroll tax revenue generated from workers (12.4% of total wages, which is often split evenly between you and your employer unless you happen to be self-employed), and interest generated from investing its excess cash reserves in very safe interest-bearing bonds, such as U.S. Treasuries. In recent years, Treasury bond yields have been anemically low due to the Federal Reserve targeting a low lending rate to fuel economic growth. Additionally, with the retirement of baby boomers we're seeing a discernable shift lower in the worker-to-beneficiary ratio. As the number of eligible Social Security beneficiaries rises, there simply aren't enough new workers taking their place.

Also, seniors are living longer than ever these days. That's reason to celebrate, and is a testament to advancements being made in healthcare. But it's also terrible news for an already burdened OASDI, as it's no longer uncommon for seniors to live two-plus decades following their retirement date. These demographic shifts are wreaking havoc on the OASDI, and it could mean a big benefits cut for retirees in less than two decades.

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Could you handle a 21% cut to your retirement benefits?

Although Congress has made a few minor changes to Social Security since the last big change in 1983, which saw the passage of a law that would eventually raise the full retirement age to 67, lawmakers have been unable to come up with an amicable solution to fix the program's expected cash outflow. And make no mistake about it, lawmakers have known for a long time that the OASDI was on an unsustainable path. If Congress were to simply continue kicking the can down the road, based on estimates in the Trustees' report, retirees' benefits could need to be slashed by up to 21% to ensure the solvency of the program through 2089.

Making matters even worse, the vast majority of Social Security recipients (about 3 in 5) choose to file for benefits before their full retirement age, ensuring they're paid less than 100% of their benefit amount for the remainder of their lives. Now imagine if this already reduced amount receives another 21% haircut. Could you cope with that?

My guess, based on the aforementioned polls and the Trustees' report, is that most households would struggle. This is why it's all the more important to focus on the little things to ensure Social Security is only a minor or negligible source of your income during retirement.

Focus on the little things

The two strategies that'll likely put you onto a path where a 21% cut in Social Security benefits won't derail your golden years are investing for the long-term and investing wisely.

You've probably been preached to before about the importance of saving early and often, but those savings may do you no good if you're not turning around and investing them in the right investment vehicles. The stock market may seem like a bumpy ride at times, but historically it's returned around 7% annually. For investors, that means doubling your money over the long-term about once every decade. If you begin investing in your 20s, you could wind up doubling your money four, five, or six times over your lifetime.

The key here is to find quality investments and think over the very long-term. Stock mogul Warren Buffett prefers a holding period of forever, and while I'm not saying you need to hold your investments that long, you should think with a long-term timeframe, investing in companies you can buy and hang onto for at least five or 10 years and beyond.

Additionally, with medical costs rising and life expectancies lengthening, you'll need to understand that investing isn't something that stops when you cross the retirement finish line. This means you could be investing with the intent of building upon your nest egg for decades after retirement.

Image source: Pixabay.

The other strategy is to invest wisely. By this I mean ensuring that you get to keep as much of the money you earn as possible instead of paying it back to the government via taxes. For example, investment gains in a Roth IRA are completely free of taxation as long as you make no unqualified withdrawals. Although there are some income limitations on who can contribute to a Roth IRA, those hitting the income limits probably aren't having to worry about a possible 21% Social Security benefits cut in the future. A Roth IRA is really focused on helping the low- and middle-income family hang onto more of their money come retirement.

Fully understanding the tax parameters of the state you retire in is important, too. Every state has a different take on what forms of income and retirement accounts are and are not taxable. In fact, there are 13 states that tax Social Security benefits, including four that follow the federal taxation guidelines. If you choose a tax-friendly state to retire in, you'll be paying yourself long-term dividends by extending the life of your nest egg.

I certainly don't want to contend with a 21% cut to my retirement income in my golden years, so I'd strongly suggest taking the corrective actions now to ensure you don't have to, either.

The article Could You Cope With a 21% Cut to Your Retirement Income? originally appeared on Fool.com.

Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.