Millions of older Americans depend on Social Security to provide the income they need in retirement, so any negative news surrounding the program is potentially cause for alarm. That's why the most recent Social Security Board of Trustees' report is somewhat concerning. According to the Board's latest projections, Social Security's combined trust funds will be depleted in 2034, which is consistent with last year's findings. But while this certainly isn't good news, it doesn't mean that Social Security will be going away in its entirety.
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How Social Security and its trust funds work
Social Security is a pay-as-you-go system. Current workers are subject to taxes on up to $118,500 of their income, and those taxes are used to pay today's Social Security beneficiaries. When today's workers retire, they, too, get to collect the benefits that other people's taxed wages are paying for. The problem with this system is that in recent years, more people (specifically, baby boomers) have been exiting the workforce than entering it, and if this trend continues as expected, the total amount collected in Social Security taxes won't be enough to keep up with retiree benefits.
That's where the trust funds come in. Social Security taxes are deposited into specific accounts from which benefits are paid. The funds' assets are then invested in special interest-bearing Treasury bonds that are redeemable when the funds need to be tapped.
While Social Security's total income is projected to exceed its total costs through 2019, starting then, money will need to be drawn from the trust funds to cover the program's anticipated income shortfall. And though there's enough money in the trust funds to keep paying beneficiaries until 2034, at that point, the fund's reserves are expected to be depleted. When this happens, the only income source for the program will be the money it collects via taxes.
Now the good news here is that anticipated tax revenues should be enough to pay 75% of scheduled benefits once the trust funds run out. The bad news, however, is that for those who rely on Social Security as their sole source of income, a 25% reduction in benefits could be downright catastrophic.
Retirees are falling short on savings
The National Academy of Social Insurance reports that as many as 65% of beneficiaries rely on Social Security for the majority of their retirement income. Even more frighteningly, Social Security represents the sole source of income for almost 25% of those 65 and older.
While today's retirees may not have to worry about a sudden 25% reduction in benefits, for future retirees, it's a very real possibility -- which means that those set to retire in 2034 or later need to take matters into their own hands and start saving independently. Currently, an estimated 33% of Americans have absolutely no retirement savings, while 23% admit to having less than $10,000 saved. This collective failure to save, coupled with the widespread disappearance of pensions and other such forms of retirement income, is forcing more and more Americans to put their faith in Social Security. But even without a reduction in benefits on the table, today's average beneficiary receives just $1,341 in monthly Social Security income. For many Americans, that just isn't enough to live on.
Start saving today
Unless you're willing to risk running out of money in retirement, your best bet is to forget about Social Security -- even though the program is expected to continue paying out the majority of its benefits for the foreseeable future. Even in its current state, Social Security is only designed to replace about 40% of the average worker's pre-retirement income. Most people need 70% or more of their pre-retirement income to keep up with living costs once they're no longer working. If you're looking at retiring in 2034 or later -- which means you might face a 25% benefits reduction -- you'll need to work even harder to bridge that gap.
But here's the bright side: If you're not planning to retire till 2034, it means you still have a decent amount of time to amass some savings. If you manage to save $200 a month starting tomorrow, invest it, and generate an average annual return of 8%, in 18 years, you'll have about $90,000 for retirement. Save $500 a month, and you'll have a cool $225,000 by the time retirement rolls around.
Even if future Social Security benefits do take a hit when the trust funds run out, you won't suffer from that shortfall if you're smart about saving on your own. And the sooner you begin, the better your chances of achieving financial security when it's your turn to retire.
The article Will Social Security Disappear When the Trust Fund Runs Out? originally appeared on Fool.com.
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