Millions of older Americans today count on Social Security to provide a large chunk of their monthly retirement income. And if Social Security were to cut benefits, many seniors would no doubt find themselves grappling with a major financial crisis.
Unfortunately, benefit cuts are now a distinct possibility given Social Security's impending financial shortfall. And even scarier is that they may not be so far away. So it pays for working and retired Americans alike to gear up for that possibility -- and have a backup plan.
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Why things are looking bleak for Social Security
Social Security gets the bulk of its funding from payroll taxes. And while that revenue stream is set to continue, in the coming years, it will shrivel as baby boomers exit the labor force in droves.
Of course, the natural follow-up question is, "Won't younger workers come in and make up those payroll taxes?" But the problem is that rate of replacement workers is set to fall short, leaving Social Security with a glaring deficit it will rely on its trust funds to cover.
The program's combined trust funds, however, are set to run dry in 2035, according to the most recent Social Security Trustees report. And while that date is by no means set in stone, if it is correct, it means the program may have to implement sweeping benefit cuts in a decade from now.
That's clearly a scary thought. And it's one that everyone needs to take seriously.
How to prepare for Social Security cuts
It's important to note that this isn't the first scenario where the idea of Social Security cuts has come into play. Lawmakers have, thankfully, managed to avoid cutting Social Security in the past, and there's a chance they'll pull off a similar victory this time around, too.
But that's not a given. And the problem is that every solution that's been proposed to prevent Social Security cuts seems to come with a built-in drawback.
For example, some lawmakers have proposed moving full retirement age for Social Security from 67 to 68 or 69. But while that would help address the program's solvency issues, it would effectively force millions of Americans into a delayed retirement.
Lawmakers have also suggested increasing the payroll taxes that fund Social Security. Right now, workers pay 12.4% of their wages, up to a certain limit, into the program, splitting that obligation in half with their employers (the self-employed have to cover that entire obligation themselves).
It's possible to raise the Social Security tax rate to 15% to 16%. But that would, in turn, burden working Americans with higher taxes.
That's why it's a good idea to plan for Social Security cuts. And your approach will clearly have to depend on whether you're still working versus whether you're retired already.
If you still have time in the workforce ahead of you, save, save, and save some more. Use employer matches in your 401(k) to give your nest egg a boost, and aim to save your raise each year so you're able to increase your contributions steadily over time. Also, invest heavily in stocks if retirement is a decade away or longer, as that could help your savings outpace inflation.
If you're already retired, reassess your spending and try cutting expenses. That could mean downsizing into a smaller home or giving up a car if you can find a way to get by without one. You could also look at embracing the gig economy and working a flexible job. That's something to do sooner rather than later, though, because as you age, your ability to work may become more limited.
All told, it's not a given that Social Security will be cutting benefits in 10 years from now. But it's important to accept that a broad reduction in benefits may also be inevitable this time around. Prepare accordingly so that if the news end up not being good, you won't be completely thrown for a loop.
