Follow the money

Why is the future of Social Security uncertain? Well, unlike your contributions to a 401(k) plan or IRA, the money taken from your paycheck via payroll taxes doesn’t go directly into a Social Security account with your name on it.

Rather, Social Security funds are used to pay for the retirement benefits awaiting today’s retirees. In turn, tomorrow’s benefits will be paid in part by payroll taxes on the next generation of workers, whose benefits will be paid in part by the subsequent generation. And so on.

This approach can work well, provided that enough people are paying into the system compared to the number of people collecting benefits. In previous decades, there were usually many workers supporting each recipient of benefits.

But that ratio has been dropping precipitously in recent years. And no recovery is in sight as more and more Baby Boomers hit retirement age and start to collect benefits, while life expectancies continue to increase. Unless action is taken, the current annual surpluses could conceivably turn into deficits in this decade or the next — putting the system on shaky ground.

Don’t count on it

Social Security probably won’t go away entirely. Legislators will likely implement a combination of higher payroll taxes and reduced benefits. For example, benefits might be reduced by raising the “full” retirement age to reflect today’s longer life expectancies. (The current full retirement age begins at age 65 for those born before 1938, 66 for those born from 1943 through 1954, and 67 for anyone born after 1959. For intervening years, the age increases by a number of months.) Another widely discussed possibility is a more fundamental re-envisioning of the program — perhaps to include private investment accounts for younger workers.

Whatever the case may be, your retirement plan shouldn’t depend on Social Security, but it should factor in your projected benefits. If your expected retirement date is soon, you can probably count on Social Security being there for you in its existing form. If you’re relatively young, however, it’s more likely that the program could undergo significant changes before you reach retirement age.

Find your comfort level

Whether retirement is decades away or right around the corner, you must determine how large a Social Security presence you’re comfortable factoring into your retirement strategy. Then you need to accumulate enough assets to provide yourself a comfortable retirement income when combined with the monthly government checks you expect.

Age is also a big factor when determining your strategy for building up and preserving your retirement savings — whether in tax-advantaged retirement accounts, such as IRAs and 401(k) plans, or in taxable savings and brokerage accounts. Younger investors can generally afford to own the vast majority of their retirement nest egg in higher-volatility assets, such as stocks, given their longer time horizon and ability to wait out market downturns.

But even investors in or approaching retirement should consider holding some stocks to keep pace with the rising cost of living over time. And no matter what your age, you’ll benefit from owning a diversified portfolio of various asset types. Each can be expected to move up and down at different times and help protect you against market fluctuations. Your financial advisor can help you determine the appropriate asset mix for your individual situation.

Don’t wait

Social Security isn’t as secure as most people want it to be. So make sure to integrate your Social Security benefits, whatever they end up being, into your wider retirement-funding strategy.

© 2015