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3 Reasons Social Security Faces a Funding Shortfall

Maurie Backman, The Motley Fool

There's a reason so many Americans are losing faith in Social Security: The program faces a serious funding shortfall that, if left unaddressed, could result in an across-the-board reduction of future benefits. Here are some of the reasons its finances are so rocky.

1. Too many baby boomers are retiring at once

As people leave the workforce, they begin collecting retirement benefits -- which they're entitled to after having paid Social Security taxes during their working years.

Note that Social Security pays more than retirement benefits; it also pays disability and survivor benefits. Retired workers and their dependents, however, account for 72% of total benefits paid.

Because baby boomers are retiring in droves, or are expected to in the coming years, Social Security could see a serious uptick in retirement benefit obligations.

Older man walking a dog

Image source: Getty Images.

In fact, a report issued a few years back from the Social Security Administration claimed that 10,000 baby boomers retire each day. That might seem like a gross exaggeration, but when we consider that there were 76 million people born between 1946 and 1964, and that those people are likely to retire over a 19-year period, the math works out.

2. Not enough younger employees are entering the workforce to replace them

The mass exodus of baby boomers from the workforce wouldn't be quite so problematic if enough workers were to come in and replace them. But that's not expected to happen.

Back in the 1970s and 1980s, the workforce experienced tremendous growth as baby boomers sought employment. But the U.S. birth rate has been declining over the past number of decades, and the labor force is expected to follow suit. Throw in the fact more women have been opting out of the workforce since their participation rate peaked in 1999, and we're left with a smaller number of workers as a whole. This creates a problem for Social Security, because payroll taxes are the program's main source of funding. The fewer workers there are to tax, the less money Social Security has at its disposal to keep up with scheduled benefits.

In fact, there are currently 2.8 people in the workforce for each Social Security beneficiary. By 2035, however, there will only be 2.2 workers per beneficiary.

3. Life expectancies are increasing

In 1940, the life expectancy of a 65-year-old was almost 14 years. Today, it's just over 20 years. By 2035, there will be an anticipated 79 million Americans age 65 and over, up from about 49 million at present.

The fact that life expectancies are increasing is a good thing in theory, but it presents a financial challenge for Social Security, since there's no age-related cutoff date to receive benefits; seniors who live well past 100 still collect those payments every month. As such, the program's limited monetary resources are expected to be drained even further.

What does the future hold for Social Security?

Let's be clear: Social Security is certainly in no immediate danger of going bankrupt. Because the program is funded by payroll taxes, it's virtually guaranteed to have some revenue coming in. By 2035, however, Social Security may have no choice but to implement a massive reduction in scheduled benefits to the tune of 20% as per its Trustees' latest projections.

A cut of that size could be catastrophic for current and future retirees. Workers who are years away from retirement would therefore be wise to ramp up their savings by maxing out their IRAs or 401(k)s, or getting as close as possible. Senior living costs seem to be going nowhere but up, yet there's a real possibility that in the not-so-distant future, Social Security benefits will move in the opposite direction.

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