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One of the biggest myths about Social Security today is that its bankruptcy is just a few years away. Don't get me wrong, there are funding issues that need to be addressed. But the fund is far from bankrupt.
For investors, the biggest takeaway is that no matter how the funding problem is solved, it will affect your wallet.
Historically, the Social Security fund has run at a surplus, and it's expected to do so through 2019. At that time it will need to start dipping into reserves to pay promised benefits.
Given the current income and payout rates, the Social Security fund will be able to pay 100% of benefits through 2034. At that time it will not go bankrupt, but benefits will need to be reduced by 25%.
That's because Social Security is funded mainly through this income source…
The Main Way Social Security Today Is Funded
Social Security today is funded primarily through payroll taxes.
There haven't been issues with funding for Social Security in the past because there have always been at least three tax payers for every beneficiary. But by 2034, there will be only two tax payers for every beneficiary.
This drop in the payee-to-beneficiary ratio is the cause of the upcoming deficit in Social Security funding.
Despite what many people believe, you do not fund your own Social Security benefits. Right now, that's what roughly 32% of Americans believe, according to a 2014 Pew Research survey. Instead, you actually fund your parents' and grandparents' benefits.
You pay taxes into the Social Security system, then those funds are taken to pay current retirees, disabled workers, and dependents.
To illustrate that you do not fund your Social Security payments, let's take a look at Average Joe. He makes $55,000 a year, works for 30 years, and has an 18-year retirement.
At $55,000 a year, Average Joe is contributing $3,410 a year into Social Security ($55,000 x 6.2% Social Security tax).
His employer will also contribute $3,410 a year into Social Security for a total of $6,820. If Average Joe is self-employed, he will contribute the full $6,820 to Social Security every year.
Over his 30-year career, Average Joe and his employer will contribute $204,600 ($6,820 x 30) into the Social Security fund.
At retirement, Average Joe will receive an average benefit check of $1,180.80 per month. The average retirement is 18 years and requires $255,052.80. That is $50,452.80 more, on average, than an individual pays into the system. The difference is made up by a guarantee from the government saying Average Joe will receive retirement benefits for the rest of his life and so will his widow, if she qualifies.
Because you receive more benefits than you pay into the fund, you are not actually using your money when you begin to collect Social Security. You are receiving benefits from the tax collected from the younger generation of workers.
And that's a massive problem with Social Security funding that's arising. The number of beneficiaries is rising, but the number of workers is not climbing fast enough to compensate…
3 Fixes to the Social Security Funding Problem
In order to fix the Social Security funding gap, expenses will have to be cut, revenue will have to increase, or both.
The first way to solve Social Security's funding problem is widely unpopular. Because this option is so unpopular across all demographics, it is not likely to happen. That solution is to cut benefits.
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So if cutting benefits isn't likely to happen, the other possibility is raising revenue.
The main ways Social Security can increase revenue is to raise taxes or raise the maximum amount of taxable earnings.
Increasing taxes will bring in additional revenue, but it will also limit an individual's ability to save on their own for retirement. That would make retirees more dependent on Social Security benefits.
The other option is to raise the maximum taxable earnings. Currently, that number stands at $118,500. Raising this ceiling would subject higher-income individuals to more Social Security taxes without being able to draw additional benefits when they retire.
While both options have drawbacks, it is likely that a combination of the two options to increase revenue will be implemented before Social Security benefits would be reduced.
Either way, your wallet will be affected in your working years or in your retirement. Possibly both.
But we have a way to grow your money in retirement so you don't have to worry about Social Security…