It’s pretty well accepted that everyone should save for retirement and have a retirement account, but just how important is it? Absolutely essential. And never more so than today. That’s because the prospect of a comfortable retirement based largely on Social Security benefits or monthly pension payments is less certain than at any time since the Great Depression.
Yes, we admit it: We can’t predict the future. Instead, we rely on probabilities. And in our opinion—from the vantage point of 2017—there’s a high probability that, in the future, we’ll all be spending more of our own savings to cover retirement costs. Here are a few reasons why:
- The U.S. government is deeply in debt.
- U.S. economic growth prospects, though definitely improving, look meager by historical standards in the short- to mid-term.
- A wave of retiring Baby Boomers means there will be fewer workers to foot the bill for each person receiving Social Security benefits.
- Politicians typically shy away from tackling such controversial and costly challenges as Social Security reform. And the longer they delay, the more difficult the choices—and the solutions—will be to ensure adequate benefits for generations of future retirees.
Outlining this bleak reality isn’t meant to scare you. It’s meant to motivate you to take the steps to protect yourself if things turn out for the worst.
If typical Social Security benefits shrink by the time you reach retirement age and traditional pension benefits recede into history, your best hope is to create your own retirement nest egg. And with time on your side, you can amass a sizeable stash. The key is to start now.
If the future turns out brighter than we expect, the worst thing that could happen is that you saved too much money for retirement. We think you’ll agree that’s a pretty great problem to have. We won’t pity you when you’re “forced” to upgrade to first class on that month-long trip to Hawaii or to move into a nicer retirement home.
When created in 1935 during the Great Depression, Social Security was designed as a “pay-as-you-go” system. That means that payroll taxes from current workers are used to pay the benefits for current retirees. It may have been necessary at the time, but the setup has an inherent flaw: What happens when the proportion of retirees grows far faster than the number of people working to support them?
The answer is the same as for a parent whose income is flat (or falls) every year, but who keeps having children. The parent can either earn more or go into debt; otherwise, there’s less money to spend on each child.
When it comes to Social Security, the way to “earn” more is to raise taxes. The other option is to cut benefits, a politically challenging task for the same reason Social Security is less secure: substantial growth in the number of retirees as the first wave of Baby Boomers turned 66 in 2012. And older voters, who depend on Social Security benefits, tend to outnumber younger voters who pay the taxes.
In the 1980s, a nearly bankrupt Social Security system prompted lawmakers to tweak the system to make it a bit less “pay-as-you-go.” Since then, Social Security has typically operated with a surplus (more money was received in taxes than paid out in benefits). That surplus is held in the Social Security Trust Fund. Each year, the fund’s trustees issue a report outlining the system’s financial health. And each year, the report gets grimmer.
In 2011, Social Security paid out more in benefits that it received in revenues for the first time since the 1983 reforms. The government paid $736 billion in benefits to 56 million people (beneficiaries include retirees and those with disabilities and their families). Due to temporary cuts in payroll taxes as part of recession-related stimulus programs, the system took in $691 billion. By 2016 (reported in the 2017 report), the numbers were $922 billion paid out to about 61 million people, with a total income of $957 billion. Reserves were $2,848 billion at the end of 2016. However, if you remove interest income, there’s already a $59 billion shortfall. Over time, the growing number of retirees will cause the imbalance to worsen.
It’s not something that can be fixed by returning payroll tax rates to pre-recession levels. The devil is in the demographics. In 2016, there were about 2.8 workers for every beneficiary. By 2035, Social Security trustees project that the ratio of workers to beneficiaries will drop to 2.2. As the ratio of workers to retirees shrinks, the system will have to dip into the trust fund to pay benefits. Reserves for the combined disability and old-age trust funds are likely to become depleted in 2034, the trustees project. If something isn’t done, benefits will need to be reduced. The current report says that scheduled benefits would have to be reduced by 23 percent, starting in 2034 to maintain solvency.
So what does that all mean for you? In a nutshell, your retirement income will likely take a hit, whether through lower benefits in retirement or higher taxes during your working years (leaving you with less money to save). Alternatively, the normal retirement age when you qualify for full benefits could be raised from its current age of 66. This means you’ll have to work longer—or get by with less—if you retire early. The age at which you can receive full retirement benefits is already scheduled to increase to 67 for anyone born in 1960 or after, and it’s likely to go even higher.
Is ‘Deficit’ a Dirty Word?
When it comes to your retirement, the answer is likely “yes.” While the impact of a government deficit depends on an extraordinarily complex set of factors, the basics are pretty easy to understand.
Like any individual, the U.S. government takes on debt any time it takes a loan to pay for expenses it can’t cover with its current income.
For the government, those loans take the form of bonds sold to individual investors, big institutions and other governments.
The government’s ability to repay those debts, and take on new ones, depends on both its annual income and the interest rates demanded by its investors. In recent times, actions taken to soften the impact of the Great Recession, combined with the costs of the Bush tax cuts of 2003 and the wars in Iraq and Afghanistan, has caused the country’s debt to skyrocket.
Healthy economies typically can handle deficits, because growth in the economy increases the government’s ability to pay back the debt. But the numbers indicate that, as in 1983, changes will be needed to maintain the Social Security safety net over the long haul.
The major issue for retirees is which approach the government will take to generate enough money to make its debt payments. One option is to raise taxes. The prospect of higher future taxes has particular significance for your retirement account, since choosing the right account can depend largely on whether you expect to pay higher or lower income taxes in the future. A Roth makes the most sense if you expect your taxes to go up; a Traditional IRA makes sense when you expect them to be lower.
To Our Health
And there’s one other big unknown with special resonance for seniors and everyone who worries about their own future and the prospect of caring for their parents: healthcare costs. In the U.S., healthcare is big business, accounting for nearly one-fifth of the nation’s total economic output. In fact, healthcare cost increases have outpaced economic growth in every decade since 1970s. In 2015, the most recent year for which the National Center for Health Statistics has data, the bill totaled $9,990 for every man, woman and child in the country.
As a society, Americans may be a bit obsessed with health screenings and procedures, but that alone doesn’t explain the rapid increase in costs. The factors are many, and we won’t bore you with the details (that’s a whole other book!). Suffice it to say that the evidence points to an ever-upward trend in costs. That’s likely to mean more out-of-pocket expenses for healthcare for everyone—especially retirees, who tend to require more medical services. The hit can be a double whammy: Not only will individuals spend more on personal healthcare, but they may also pay higher taxes to fund government programs such as Medicare.
The size of the increases is impossible to predict. Maybe politicians will eventually join hands and tackle the healthcare-cost problem but, if recent history is any guide, that’s probably not in the cards for the near-term future. In the meantime, store the world’s best “insurance”—your cash—in a retirement account.