Millions of retired Americans rely on Social Security to make ends meet once they're no longer working and earning a paycheck. Even though the average retiree was only collecting $1,907 a month at the start of 2024, that income is crucial for many older Americans today.
But Social Security is facing a major financial shortfall that could put its ability to pay benefits at risk. And that's something current and future retirees alike need to be aware of.
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Social Security's main source of funding is shrinking
Social Security gets the bulk of its funding from payroll tax revenue. At first, that might seem like a fairly stable source of income. But in the coming years, Social Security is expected to see a notable decline in payroll tax revenue as more and more Americans reach retirement age and exit the labor force in short order.
Social Security can tap its trust funds to keep up with scheduled benefits in the coming years and avoid having to shrink them, even as payroll tax revenue declines. But once the program's trust funds run out of money, benefit cuts will be on the table.
The latest timeline for benefit cuts
Last year, the Social Security Trustees projected that the program's combined trust funds would be depleted in 2034. However, this year's recently released report states that the combined trust funds are now projected to run dry a year later than previously expected. This means that seniors may not have to worry about benefit cuts until 2035.
Furthermore, the Trustees are now projecting that once Social Security's trust funds are depleted, the program will be in a position to pay 83% of scheduled benefits -- a higher percentage than what's been indicated in previous years. So while benefit cuts are, generally speaking, bad news, on a positive note, the date at which they may be happening has been pushed back, and the extent to which they may be happening isn't as extreme as in previous estimates.
It's important to prepare for benefit cuts now
This isn't the first time in its history that Social Security has faced the potential for benefit cuts. In the past, lawmakers have managed to find ways to avoid them, and they may very well end up with a solution this time around, too. But still, given the latest update from the program's Trustees, it's a good idea to prepare for Social Security cuts in case lawmakers are unable to bail the program out this time around.
In this regard, workers and pre-retirees have a huge advantage over current retirees. Younger workers can take steps to build more savings so they have more cash reserves to tap. Because time is on their side, this can be done without even having to part with huge sums of cash on a monthly basis. Case in point: A $450 monthly contribution to a retirement plan delivering an average annual 8% return (which is a bit below the stock market's average) over 35 years will result in a nest egg worth about $931,000.
Near-retirees, meanwhile, can push off retirement and take advantage of catch-up contributions in their IRAs or 401(k)s. They can also look to ease into retirement rather than suddenly stop working, to avoid tapping their existing savings for a longer period of time.
Current retirees may have fewer options for compensating for Social Security cuts. But now's a good time to assess and reduce spending to bank some savings and consider embracing the gig economy. Working a few hours a week on a flexible basis could help older Americans build or boost savings in a very meaningful way.
All told, Social Security cuts may now be set to arrive a year later than expected. That's good news to some degree, but it's an update workers and retirees alike need to take to heart and act on while they can.
