Why it's time to start planning for Social Security

Social Security may last longer than you think. Saving for a future with Social Security -- even if Social Security's funds are depleted -- may prevent consumers from saving too much or too little right now.

Everything you think you know about Social Security is probably wrong.

The system isn’t “running out of money.” It’s not going bankrupt. And the chances are quite good that millennials will receive benefits from Social Security — although half of them don’t believe it, according to a 2014 Pew Research Center study.

Not understanding how Social Security works can be hugely detrimental to your future retirement. Among the ways:

You may not save enough. It’s tempting to give up in despair when you see the huge numbers you’d need to save to replace your income in retirement. But the money you’ll get from Social Security reduces that amount, often dramatically.

Figure that every $100 per month you get from Social Security equals $30,000 less that you have to save. (You would need to have about $400,000 in savings to generate today’s average monthly retirement check of $1,335, assuming a 4% annual withdrawal rate.) Understanding Social Security’s role can make the amounts you need to put aside more manageable and achievable.

(Try the NerdWallet retirement calculator to run the numbers on what you might need. It can figure out what you’ll need to save at various income-replacement levels: current spending, a little more, a little less. “A little less” reflects what you might be able to retire on if Social Security makes up the difference.)

You may save too much. Social Security is designed to replace 40% of the average worker’s income. The replacement rate declines the more money you earn, but Social Security is still likely to provide a significant chunk of income. If you save as if Social Security won’t exist, you may have trouble putting enough money aside for other goals while living a balanced life in the present.

You may not be vigilant enough. When politicians try to mess with Social Security (and they will), you may not understand how much you have to lose. Those who would gut Social Security are counting on millennials’ ignorance and indifference. So are those who want to preserve the system by foisting the most egregious changes on the youngest workers.

People born in 1960 or after are already taking a benefit cut, in the form of a higher retirement age — 67, up from today’s full retirement age of 66, says Mary Beth Franklin, a certified financial planner and Social Security expert who writes for Investment News.

“Proposals to cut future benefits without reducing their current taxes would be a raw deal” for millennials, Franklin says.

Social Security is insurance, not an investment

First, understand that Social Security is an insurance program, not a retirement savings plan. Social Security is meant to protect you against poverty in old age by giving you a stream of income you can’t outlive.

You don’t have money set aside for you in an account, as you would with a 401(k) or an IRA. Instead, money is taken from every paycheck you earn and used to pay benefits to people who have already retired. When you retire, your benefits will come from taxes paid by those who are still working.

The pay-as-you-go system worked pretty well for most of Social Security’s existence. Starting in 1983, Congress raised payroll tax rates to build up a cushion against the coming wave of baby boom retirements. (The Social Security rate is currently 12.4%, with half paid by the employee and half paid by the employer. The self-employed pay both halves.) The surplus was invested in special-issue Treasury securities — essentially, IOUs written by the federal government so it could use the money in other programs. These IOUs aren’t “paper promises,” as some have mischaracterized them. Treasurys are backed by the full faith and credit of the United States, which has never defaulted on an obligation.

Which is a good thing, since Social Security has started to pay out more in benefits than it collects in taxes. Interest paid on those Treasury securities makes up the difference for now, but in a few years the system will have to start cashing in those IOUs. Somewhere around 2034, the last IOU will be cashed.

At that point, Social Security expects to collect enough in taxes to pay only about 75% of promised benefits.

We need to act, not panic

There’s a difference between “running short” of money and “running out.” Too many people opining about Social Security don’t seem to understand that. Getting only 75% of what you were promised is a bummer, but it’s hardly the same as getting 0% of what you were promised. And benefit cuts would be extremely unpopular — even millennials, the generation farthest from retirement, are against cutting benefits for current retirees.

There are other ways to fix the system. A lot of them, actually. Raising the tax rate from 6.2% to 7.4% for both employees and employers would solve most of the problem. So would subjecting all wages to the tax (currently the tax doesn’t apply after a certain cap, which this year is $118,500) and raising the full retirement age by a year or two, to 68 or 69, for those born in 1960 and after. You can experiment with different solutions with this little game created by the American Academy of Actuaries.

Social Security is too popular to disappear. Nearly 60 million people get a check from the system, and Social Security benefits make up half or more of most people’s retirement income. That explains why attempts to privatize or otherwise radically change the system have gone nowhere. Even a Republican president with a Republican Congress couldn’t do it; President George W. Bush had to abandon his attempt to partially privatize the system in the face of overwhelming opposition.

To avoid cutting benefits, though, Congress will have to act.

The longer our lawmakers delay, the more severe the changes will have to be — and the more likely politicians are to make younger generations pay more of the cost. If you don’t want to bear the brunt of their procrastination, it’s time to call or email your congressional representatives.

Tell them you know they can preserve Social Security, and you expect them to do so.

Liz Weston is a columnist at NerdWallet, a personal finance website, and author of “Your Credit Score.” Email: lweston@nerdwallet.com. Twitter: @lizweston.

This article first appeared in NerdWallet.