How Will Social Security Deficits Impact Your Retirement?
By Aimee Calderon, CFP®
President Franklin D. Roosevelt signed the Social Security Act into law in 1935 during the Great Depression. Since then, Social Security has often been described as one leg of a three-legged stool that supports retirees in America. The other two legs are employer pensions and employee savings. Over the last 80 years, however, employer pensions have become scarce, and therefore the retirement stool now has only two legs for many retirees.
Meanwhile, the Social Security Trustee Board provides an annual report on the health of the Social Security program. The most recently published report shows that for the first time since 1982, the benefits paid out annually to Social Security beneficiaries have exceeded the total income of the program. Total income includes payroll taxes and interest earned on the reserve.
The report by the board of trustees also projects that the reserve will be depleted by 2035. Some people may be surprised that there even is a Social Security reserve. In 1983, Congress raised payroll taxes to build up a surplus for the onslaught of baby boomers who would be retiring. For about 30 years, the program brought in more revenue than it paid out. That all recently changed, and now this reserve is projected to be depleted in 2035.
Demographics play a big role in the Social Security budget deficit. Millions more baby boomers are collecting their retirement benefits from Social Security than Generation Xers are contributing to the program. In addition to the shortfall of contributing members, the average life span is increasing in the United States. It is projected that there will be 73 million Americans collecting Social Security benefits in 2035. This is about 35% more than in 2018.
What can be done for Social Security to remain solvent? There are three options, none of which is appealing:
Benefits will be reduced.
Payroll taxes will be increased.
Both of the above.
What Can You Do?
So, with the Social Security leg of the retirement stool seeming very wobbly, the remaining leg of employee savings is becoming crucial. There are many ways to save for retirement on your own. Here is a summary of the retirement plans that you should consider utilizing.
Employer-sponsored plans: Most often, these accounts comprise 401(k) plans in the for-profit sector and 403(b) plans in the nonprofit sector. Such plans often have employer-matching contributions available. Never leave free money on the table. If your employer will match your contributions, make sure you are contributing enough to get the full match. Your contributions are also tax- deductible. While your withdrawals will be taxed in retirement, your capital gains and dividends are tax deferred. Current 2019 law limits employee contributions to $19,000 per year but also allows an additional $6,000 per year if you are age 50-plus.
Self-employed plans: If you work for yourself, you can explore a myriad of retirement plans. There are single-person 401(k)s, SEP-IRAs, SIMPLE IRAs, and defined-benefit plans. Contributing to a self-employed plan can greatly help reduce your taxes now while you are saving for retirement. While the rules for each plan are different, you can consult a fee-only financial planner to help you navigate the self-employed retirement plan options.
Individual retirement accounts (IRAs): Most people contribute to IRAs to get the tax deduction. However, even if you’re not eligible for the deduction (because your income is too high or an employee plan covers you), you can still contribute to a non-deductible IRA where your money will grow on a tax-deferred basis. In 2019, you may contribute up to $6,000 per year to an IRA plus $1,000 if you are age 50-plus. You may contribute to an IRA only if you have earned income and are under age 70 1/2.
Roth IRAs: Contribution limits are the same for Roth IRAs and traditional IRAs. However, you can contribute to a Roth IRA after age 70 ½ as long as you have earned income. The major difference between a Roth and a traditional IRA is that you do not receive a tax deduction for Roth IRA contributions. The good news is your Roth IRA grows tax-free, and you do not pay taxes on withdrawals in retirement.
Personal accounts: If you can save above and beyond the limits mentioned in the plans above, you should start contributing to a taxable account as well. While you do not receive a tax deduction or tax deferral in a personal account, your money will still be invested and can grow for retirement. Unlike most retirement plans mentioned above, withdrawals from personal accounts are not taxed.
As we help our clients prepare for retirement, we always run a retirement projection. This projection includes many figures and assumptions such as:
Retirement age goal
Investment return assumption
Pension and Social Security benefits
Additional sources of income (e.g., rental income)
After inputting all this data, we can produce an annual spending figure for our clients. Often, clients are surprised by how much it takes to retire at a comfortable level. We can also set a goal for annual retirement income, and then the projection tells the client how much they need to save per year to meet that goal.
Tips for a Comfortable Retirement
Here are some tips to help you save for retirement:
Start early. If you are starting out in a career, open an employer-sponsored retirement plan such as a 401(k), and contribute as much as possible (at least enough to receive a company match). Time is on your side if you start young, and you will thank yourself later.
Pay yourself first. If you are saving in an employer plan, you are most likely saving monthly right out of your paycheck. If you are saving to an IRA, Roth IRA, or personal account, set up monthly automatic transfers to these accounts. Do not wait until the end of the year to see what you have left over to save.
Track your spending, and set up a budget. Many clients of our Fullerton financial planning firm initially had no idea how much they were spending on discretionary items. To understand where your money is going, write down everything you spend over a month or two (or keep track of it using an online budgeting assistant like Mint or Quicken). Once you have a clear picture, you can start looking at places to cut so that you can save more.
Get out of debt. While owning a home in Orange County, California, is nearly impossible without a mortgage, the main point is to live within your means. Paying off high-interest credit card debt and car loans should be a priority. Many of our clients also have the goal of paying off their mortgage by retirement so that they will need less retirement income.
As the Social Security outlook is not great, it is now more important than ever to take control of your retirement savings. A fee-only financial planner can assist you in navigating and planning for your financial future. Look for one who is a fiduciary so you know that their recommendations are made in your best interest.
Schedule a 15-minute discovery call with a fee-only financial advisor to discuss your personal situation.