A looming Social Security gap could trim benefits by about 22%

More than one in five Americans do not realize that their monthly Social Security payments could be cut by about 20% within six years.

According to the latest Social Security and Medicare Trustees report, Social Security’s reserves could be exhausted at the end of 2032. If lawmakers make no changes, the Old-Age and Survivors Insurance Trust Fund would then be able to pay only about 80% of scheduled benefits to retirees.

“Many Americans plan around Social Security as a reliable, steady source of income in retirement,” said Tim Pitney, head of lifetime income distribution at TIAA, which surveyed U.S. adults about the program’s outlook.

“But when a benefit cut arrives without awareness or warning, workers who have spent years relying on Social Security as the foundation of their retirement will have fewer savings to fall back on, and far less time to rebuild them.”

How the program is financed

Social Security benefits are paid for through payroll taxes that flow into trust funds and are then distributed as monthly checks to millions of retirees and Americans with disabilities.

The tax applies only up to a yearly earnings cap. In 2027, the maximum amount of income subject to Social Security tax is set to rise to $192,300, up from $184,500.

Workers and employers each pay 6.2% on wages up to that limit. Self-employed workers pay the full 12.4% payroll tax.

Social Security currently sends monthly benefits to about 71 million Americans and provides the majority of income for 43% of seniors, according to AARP.

Possible fixes

The trust fund’s projected depletion has been building for decades.

“It’s one of the most predictable events in public policy,” said Shai Akabas, vice president of economic policy at the Bipartisan Policy Center. “What’s different now is that this serious economic shock of a 22% across-the-board benefit cut has started coming into clear focus.”

One of the most contentious ideas in Washington is raising or removing the payroll tax cap.

“Closing the gap would require raising revenue (a higher payroll tax rate or taxable wage cap), reducing benefits (a later retirement age or slower cost-of-living adjustments) or a combination of both,” Torsten Sløk, chief economist at Apollo Global Management, recently wrote. (Disclosure: Yahoo is a portfolio company of funds managed by affiliates of Apollo Global Management.) Another proposal would have the Social Security Administration borrow heavily and invest the borrowed money in the stock market.

Congress has only two broad choices to address the expected shortfall: bring in more money or reduce benefits, Nancy Altman, president of Social Security Works, previously told Yahoo Finance.

“Social Security’s future is on the ballot this November,” Altman said. “Anybody elected to the Senate will likely be in office and voting on that legislation to reform Social Security.”

‘Not enough to cover the gaps’

After learning about the potential shortfall, more than 2 in 10 Americans say they expect to rely more on personal savings, raise workplace retirement contributions, or put more money into an individual retirement account, according to TIAA’s data.

“This is an encouraging movement, but it’s still not enough to cover the gaps a lack of Social Security benefits could bring,” Pitney said.

Over the past year, nearly half of Americans have paused retirement saving to pay for everyday expenses, while only 7% have increased retirement contributions, TIAA found.

At the same time, half of Americans say keeping up with daily living costs is their top financial priority, well ahead of those who say saving for retirement is their main concern.

“When presented with information about Social Security’s trust fund depletion, Americans understand the urgency and rank Social Security reform as the third most pressing option for lawmakers to address, after bringing down the high cost of living and healthcare costs,” Pitney said.

He added that people recognize the need to save and are looking for ways to secure their financial path through retirement.

“The bottom line is that a possible 22% benefit cut makes it more important for households to save more and build a stream of income in retirement,” Apollo’s Sløk said.