Key Points
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If you’re fearful that Social Security is going away, there’s no need to have that concern.
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Because Social Security is funded by payroll taxes, it can’t completely run out of funds.
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Benefit cuts are the worst-case scenario to gear up for right now, but it’s important to prepare for those thoroughly.
There are millions of older Americans who collect Social Security in retirement. And for many, it’s an essential source of income.
If you’re banking on Social Security as a retirement income stream, the rumors that the program may be going bankrupt could be throwing you for a serious loop. But you should know that Social Security actually can’t run out of money, for one big reason.
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How Social Security gets funded
Some people assume that the government has a large but limited pool of money that Social Security benefits get paid out of, and that once that money is gone, so too will the program disappear. But that’s not at all how Social Security works.
Social Security gets funded on an ongoing basis by payroll taxes. If you see a FICA line item on your paycheck, that’s money of yours that’s going into Social Security.
As long as people keep working and paying into Social Security, the program can continue to exist. So if you’ve been hearing that Social Security’s trust funds are close to running dry, don’t assume that means the program is coming to an end.
Social Security’s trust funds are essentially cash reserves the program can dip into to keep up with scheduled benefits. Think of them the same way you would your own savings account.
You might have a savings account to cover surprise expenses, or to dip into during periods when your costs exceed your earnings. But your savings account doesn’t take the place of your paycheck from work. Similarly, Social Security relies mostly on payroll taxes for revenue, and it has its trust funds to fall back on as needed.
What’s the worst-case scenario for Social Security?
There’s no reason to think Social Security won’t continue to be funded in the coming years. The problem, though, is that a shrinking workforce is expected to lead to less revenue for the program.
For this reason, it’s expected that Social Security will need to tap its trust funds in the coming years to keep up with its scheduled benefit payments. Once those trust funds run out, benefit cuts may be on the table.
The Social Security Trustees’ most recent update has the program’s trust funds, if combined, running dry in 2034. From there, it expects only 81% of benefits to be payable.
For this reason, as of now, that’s the worst-case scenario you should plan for. But you should take steps to prepare for potential benefit cuts rather than just assume they won’t happen.
If you’re still working, that means saving as best as you can. Socking away $300 a month over 40 years could leave you with almost $933,000 if your portfolio generates an 8% yearly return during that time, which is a touch below the stock market’s average.
If you’re already mid-career, you may need to save a larger amount of money per month to amass a nest egg that’s similar in size. And you also don’t necessarily need $933,000.
But ideally, you should enter retirement with a decent chunk of money to supplement your benefits. This actually holds true whether they’re reduced or not. But it’s especially important given the potential for cuts.
While Social Security is not in danger of going away, benefit cuts could happen. The more you prepare, the less financially stressful that scenario might be in the future.
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