Social Security is on pace to exhaust its reserves by 2033. And while it may seem like a long way off, it’s not.
Today, 56 million Americans rely on Social Security and they receive an average monthly check of $1,125. Sadly, this monthly sum is the only source of income for the vast majority.
Why is Social Security in trouble? And what does it mean for people who require a stable source of income?
Social Security = Social Insecurity
Contrary to popular opinion, Social Security was not created because of public demand. “It was sold by the slickest devices of Madison Avenue,” stated Milton Friedman, a Nobel Prize winning economist.
The very language behind Social Security is misleading. For instance, the payments that Social Security recipients receive are commonly referred to as “benefits,” but the truth is they are subsidies. Here’s what’s occurring: Younger tax payers, via Social Security taxes, are subsidizing the payments received by retirees.
In recent years, the instability of Social Security has become news.
On July 28, 2012, the Social Security system celebrated 75-years of mismanagement. As politicians celebrated on the House Steps of the Capitol and bragged about the financial soundness of the System, there was no mention of another important milestone achieved by Social Security: It now pays out more in benefits than it receives in payroll taxes.
The “Early Claimers”
Another element of the Social Security income deficit problem is the “early claimers.” These are the people who have been forced to collect their Social Security benefits sooner than planned. Most of the early claimers are retirement age but are either unemployed or work part-time. Others have completely exhausted their savings.
The Center for Retirement Research at Boston College estimates that early claimers experienced a 4.6% decline in benefits or a monthly reduction of Social Security benefit checks by $56. While a 4.6% decline might not seem like much, it’s a lot to be losing for income strapped people with no other significant source of income.
Hurt by Low Rates
The Federal Reserve Bank’s low interest rates have contributed to the problem facing Social Security recipients. The other part of their income source – the money they’ve invested in dividend paying stocks like iShares Dow Jones Select Dividends (NYSE:DVY), Treasury bonds such as iShares Barclays 20+ Yr. Treasury Bond (NYSE:TLT), and corporate bonds like iShares IBOXX Corporate Bond (NYSE:LQD) aren’t generating enough cash flow.
As a result of low rates, the Fed has forced income savers to take greater risks with their money. Previously risk averse investors, have now been piling into high risk areas like iShares High Yield (junk bonds)Bond Fund (NYSE:HYG), master limited partnerships through Alerian MLP ETF (NYSE:AMLP) and even emerging markets via Power Shares Emerging Markets (NYSE:PCY).
Attacking the Problem
The March 2012 edition of the ETF Profit Strategy Newsletter said, “None of the traditional income (including Social Security) methods are helping people to overcome their income shortfall. And other methods like buying longer-dated bonds or high yielding stocks come with their own set of problems.”
Instead of relying on the instability of Social Security, smart investors are already creating alternative sources of income. People, especially those ages 46 or younger, should no longer be factoring in Social Security payments into their retirement plan.