Social Security's Old Age and Survivors Insurance Trust Fund is expected to run out of money in 2034. Unless Congress can agree on reforms to the program that solve its funding imbalance before that happens, retirees could see their benefits reduced by 20% in 2035.
Such a big cut in benefits would cause a serious financial hardship for many seniors. If you're worried about the future of the program, you'll want to take matters into your own hands. Here are three things you can do to improve your chances of enjoying a comfortable retirement regardless of what happens to the government's old age benefit.
1. Save more on your own
While you should always strive to save as much as you reasonably can for retirement, if you're worried about the future of Social Security, you should be looking for ways to save even more.
This year, the average Social Security retirement benefit is about $1,625 per month. A 20% cut to that would equate to a loss of about $3,900 in benefits every year. In order to replace that income, you'll need around $100,000 extra in your retirement portfolio (per person) by the time you reach retirement age, based on the 4% rule.
So how much more would you need to save each year to hit that target?
That depends on when you're going to retire. For example, if you expect to retire in 2035, 13 years from now, you would need to save and invest about $470 more per month, assuming an expected annualized return of 5% after inflation.
You'll need to adjust that figure for inflation as well. Remember, Social Security benefits get an inflation adjustment every year, so your savings plan needs to get one too.
If your expected retirement date is further in the future, the sizes of your monthly contributions to your nest egg can be smaller. You may also be more aggressive with your investing strategy since you'll have more time to recover from potential downturns. That could allow you to reap higher overall returns.
2. Reduce your payroll tax-eligible earnings
If you're worried about the future of Social Security, you may find it counterintuitive that your strategy should involve reducing the amount of money you pay into the program during your working years. But you can use the money you avoid paying in Social Security wage taxes to help fund your personal retirement accounts.
If you have a high-deductible health insurance plan that makes you eligible to contribute to a health savings account (HSA), you can fully fund the HSA with tax-deductible contributions, and — assuming you don't need those funds for medical bills — let those savings grow. The government is boosting the HSA contribution limit to $7,750 for family plans next year. If you use your HSA like an extra retirement account, it could turn into a significant nest egg in short order. Maxing out that contribution would save you almost $600 in FICA taxes. Plus, those contributions reduce your income tax bill.
If you're self-employed, you may have the opportunity to reduce your eligible earnings even further. Setting up an S-Corp — or a limited liability corporation (LLC) taxed as an S-Corp — will allow you to determine your own wages, which can be below your actual earnings. The key is that your wages need to be “reasonable,” which is a vague term, so consult a professional on what's reasonable for your line of work. Excess earnings from your business on top of your wages pass through as a dividend to the shareholders (that's you).
Setting up your own W-2 may also allow you to significantly reduce the amount of your income that is subject to FICA or self-employment taxes. That's especially valuable for self-employed people, who pay both the employee and employer portions of their FICA taxes. Your extra savings can go toward funding private retirement accounts. Consult a professional if you think you might benefit from setting up an LLC or an S-Corp.
3. Optimize your finances for retirement
Even if Social Security cuts the benefits it pays out, you should make the most of what you will receive.
One thing to consider is how your benefits will get taxed. Unless Congress changes things, taxes on your Social Security benefits will start kicking in when you have a combined income (i.e., adjusted gross income plus half your Social Security benefits) of just $25,000 for an individual or $32,000 for a couple. At that level, you'll pay income taxes on 50% of your benefits, but if your combined income exceeds $34,000 for an individual or $44,000 for a couple, you'll pay income taxes on 85% of your benefits (these thresholds are fixed and not automatically adjusted for inflation).
To reduce your combined income in retirement, you can invest money in accounts from which the distributions you take don't count toward your adjusted gross income. Specifically, distributions from Roth accounts have no impact on that number. So the more money you can contribute or convert into a Roth while you're working, the less you'll pay in taxes later. Any principal withdrawn from a regular brokerage account also won't count, so tax gain harvesting early in retirement may benefit you as well.
You may also want to delay the point at which you file for Social Security benefits for as long as possible. If you won't be eligible to start collecting benefits until well after 2035, you won't gain anything from filing for Social Security at 62. If you can afford to, your best bet will be to wait until you turn 70. That will give you more time to set up your finances to reduce your tax burden while maximizing your delayed retirement credits as well.
Take control and stay optimistic
Social Security was never intended to be enough to cover all of a person's retirement expenses. But taking a more aggressive approach to preparing for retirement and reducing your reliance on the funds that program distributes will improve your chances of enjoying the type of retirement you want, regardless of what happens to program benefits in the future.
Personally, I'm optimistic Congress will pass a reform bill that fully funds the program and retains benefits at their promised levels well into the future. That said, I'm still maximizing my take-home pay and saving as much as I can in my own retirement accounts.
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