What Social Security's Underfunding Means for Your Retirement

The baby boomers will get their payouts, but what about the rest of us?

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Social Security and Medicare's annual checkup revealed that the recession and longer life expectancies are taxing the health of the entitlement system. The Social Security Board of Trustees report found that program costs will exceed tax revenues in 2016, a year sooner than predicted in last year's report. The trust fund will be exhausted in 2037, four years sooner than the 2008 estimate. Here's a look at how the projections could affect your retirement plans.

Smooth sailing for the baby boomers. In 2037, the year the trust fund is currently projected to be depleted, the youngest baby boomers, currently age 45, will be 73. It's highly unlikely that baby boomers will face a rise in the retirement age or cuts in benefits. "The good news for current beneficiaries and those nearing retirement is that your benefits will remain secure and intact for the foreseeable future," says Nancy LeaMond, executive vice president of AARP, a lobbying group for older Americans.

Changes for younger people. Social Security and Medicare will still be around for younger generations. But there is some uncertainty about whether there will be tax increases, benefit cuts, some combination of the two, or other fixes to correct the underfunding. "You can sort of count on the fact that if there are any changes in benefits they will be in a downward direction, and then individuals like us will have to provide more of our own income through our own personal savings and our employer-provided plans," says Bruce Schobel, president-elect of the American Academy of Actuaries. "I think it's a very safe bet that in the process of restoring financial soundness, the government is very unlikely to expand the benefits."

[See 3 Unusual Strategies for Claiming Social Security Benefits.]

Making up the difference. Social Security currently replaces about 41 percent of preretirement income for most Americans when they retire. Americans without traditional pensions who want to maintain their standard of living after retirement need to save whatever amount they need above that on their own. We don't know exactly how the government will recalibrate the retirement system to fix the shortfall, so younger Americans can't calculate precisely what their retirement benefits will be. But it can't hurt to save or invest a little extra cash in case benefit amounts decrease.

[See 10 Sources of Retirement Income.]

Longer life expectancy. In addition to the recession, Americans' increasing life expectancy is contributing to the depletion of the Social Security trust fund. "Americans are living slightly longer than we'd previously assumed," says Andrew Biggs, a resident scholar at the American Enterprise Institute and a former deputy commissioner of the Social Security Administration. "Increased longevity means more people collecting benefits for longer, which is a recipe for larger deficits." Americans now generally live 17 to 19 years after age 65, up from 12 to 13 years in 1940. The Obama administration has said it does not have plans to raise the retirement age and instead favors plans to raise Social Security payroll taxes for those making over $250,000 a year by 2 to 4 percent (combined employer and employee), but a future administration could. Younger workers may want to plan to work a few years past their current full retirement age, 67, for their own financial security. Working just an extra year or two is one of the quickest ways to pad your retirement accounts and reduce the number of years over which your savings must be spread. Plus, under current law, Social Security payouts increase for each year you delay signing up between age 62 and 70.

[See why career changers after age 50 are permanently worse off.]

Making Medicare healthy. Medicare's funding ailments are expected to occur even sooner than Social Security's. Projected annual assets for the hospital insurance portion of Medicare are expected to exceed expenditures by 2012. The hospital insurance trust fund is expected to be exhausted by 2017, two years earlier than projected in last year's report. Medicare Part B, which covers doctors' bills and other outpatient expenses, and Part D prescription drug coverage are more adequately financed in the short term, but increases in healthcare costs over the long term will average 6.4 percent annually and require increases in enrollee premiums and general revenue funding.