The importance of Social Security simply cannot be overstated, especially for today's retirees. Tens of millions of people rely on Social Security benefits right now, and tens of millions more are counting on it being there when they need it in the future. Yet when you take a close look at the program, you can see some flaws that could endanger its ability to provide the financial support you need in retirement.
Social Security is vital for a majority of seniors
When Gallup questioned retirees about their reliance on the program, nearly 6 in 10 admitted that it was a major source of their monthly income. Another 3 in 10 pegged Social Security income as a minor source. A similar study conducted even more recently by the Insured Retirement Institute on pre-retiree baby boomers found almost identical data, with 59% of boomers expecting Social Security to be a major source of their income. This was up from 43% when IRI last asked boomers about their expected reliance on the program.
Yet, for such a vital program, Social Security is hardly on solid footing. A major uptick in the number of seniors retiring due to boomers leaving the workforce is going to add tens of millions of new beneficiaries to the program in the decades to come. This is expected to push the worker-to-beneficiary ratio from 2.8-to-1 in 2015 to 2.1-to-1 by 2035. Also, people are living longer than ever -- and while that's great for us, that's bad news for the Social Security Trust, which is already strained.
The result? According to the Social Security and Medicare Board of Trustees, the Old-Age, Survivors and Disability Insurance Trust Fund is expected to exhaust its cash reserves, which currently sits at $2.83 trillion as of the end of April 2016, by 2034. To be clear, this doesn't mean the program will then be bankrupt. What it does mean is that if lawmakers choose not to put forth a workable solution to bring in more revenue and/or reduce benefits, a benefit cut of up to 21% could be needed to sustain the program an additional 55 years. Not exactly an ideal scenario for seniors who are dependent on Social Security income as their primary source to pay their bills.
This Social Security snapshot reveals a big concern
But there's another concern with the OASDI besides the ongoing retirement of baby boomers that's often overlooked. A problem that I'd opine is just as serious. Namely, the investment holdings of the OASDI Trust.
Image source: Social Security Administration.
Above you can see a snapshot of the investment holdings of the OASDI as of the end of April 2016, all $2.83 trillion worth. As you'll note, the OASDI only invests in special issue bonds and certificates of indebtedness, which are offered by the federal government just for trusts and are not available to the public. In the past, the OASDI did invest in publicly traded bonds backed by the U.S. government, but ceased doing so many years ago.
As you can see from the OASDI's investment holdings, it's currently earning as average yield of 3.206%, which is indeed higher than the current rate of inflation. But there's a dilemma. The Federal Reserve has been walking on eggshells for more than seven years due to weakened U.S. and global economic performance. The result is that we've seen near-historic low lending rates in the U.S. pretty much since Dec. 2008. Again, that's great for the consumer who's looking to buy a home, or the business looking to take on debt in order to expand, but it's terrible news for seniors and the OASDI, which are reliant on interest-bearing assets.
Take a look above and you'll see that the highest interest-bearing assets are all due to mature within the next six years (and many by the end of 2017). The remainder of the OASDI's investment holdings are in interest-bearing special issues with yields of 1.375% to 4% that could, in many cases, stretch out an additional 14 years. In fact, the bonds with the furthest maturity dates are all at sub-3% interest rates. While secure, the income generated from these bonds simply isn't cutting it. In other words, the Federal Reserve's long-term accommodative monetary policy is potentially expediting the exhaustion of the OASDI's excess cash reserves.
You need a Plan B
What the above data adds to an already lopsided argument is that you need to have a Plan B available when you retire. Simply hedging your bets on Social Security probably isn't going to be a wise move, even if you manage to work until age 70 and maximize your benefit payout.
Instead, regardless of your age, you'll need to focus on the bread and butter of retirement: saving more and investing wisely.
Nowadays, it's not enough to simply sock some money away and hope it performs well in an investment portfolio. With so many seniors reliant on Social Security, and baby boomers expected to be reliant on Social Security, it obvious that people aren't optimizing their savings. It's somewhat understandable considering that boomers and current retirees didn't have the ease of use that comes with budgeting software when they were saving for retirement. However, there are no valid excuses anymore. Budgeting software is practically everywhere, and with about 30 minutes and a few clicks you can have a straightforward plan to optimize and adjust your saving habits on a month-to-month basis.
A few suggestions you may want to consider to truly ignite your savings potential include setting up an automatic money transfer on a weekly, biweekly, or monthly basis that transfers money to an investment account to hold yourself accountable. Accountability can also be improved by getting everyone in your household, including kids, grandkids, and grandparents, involved with budgeting. The more you surround yourself with people who have similar goals, the more likely you'll be to succeed.
On the investment end, the wisest thing you can do is contribute to tax-savvy retirement tools. Matching a 401(k) contribution from your employer is often a smart move, since you're essentially being given free money, though you'll owe taxes on your 401(k) once you begin making withdrawals during retirement. More employers are using 401(k) matches as a talent retention tool, so make sure you're taking advantage of yours if one is offered.
By a similar token, a Roth IRA can be a great investment tool for people of all ages. A Roth IRA allows your money to grow tax-free for life, although you'll want to ensure you meet the income requirements that allow you to contribute to a Roth IRA. Of course, if you earn too much, you're likely not going to be counting on Social Security and living paycheck-to-paycheck in the first place. A Roth IRA also has no restrictions on age for continued contributions, and there's no required minimum distribution as with a 401(k) or Traditional IRA, meaning your money can continue to grow if you choose to let it do so.
In sum, Social Security will be there for you when you retire, but make sure it's not your only option when you hang up your work gloves for good.
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