Social Security is a federal benefits program the United States developed in 1935. While the program encompasses disability income, veterans' pensions, public housing and even the food stamp program, it is most commonly associated with retirement benefits. However, if you still have many working years ahead of you, you may not be able to depend on these benefits as a source of income. In this article, we go over how the Social Security system works and why it is predicted to fail in the future.

TUTORIAL: Qualified Plans

The Social Security system is funded through payroll taxes. The Federal Insurance Contributions Act (FICA) mandates a 12.4% levy on the first $118,500 (2016 limit) of each individual's earned income each year. The employer pays 6.2% and the employee pays 6.2%. Self-employed individuals pay the full 12.4%.Contrary to popular belief, this money is not put in trust for the individual employees who are paying into the system, but is used to pay existing retirees. Any excess is invested in U.S. Treasury bonds.

Earning Social Security Credits

Eligibility for Social Security benefits is accrued over time. Prior to 1978, workers were required to earn $50 in a three-month quarter in order to receive one Social Security credit. The achievement of 40 credits, accrued over 10 years of working, provided eligibility. Today, employers report earnings once per year instead of quarterly. Credits are accrued based on your earnings, not on a quarterly basis, so it is possible to earn all four credits for the year even if you only work a short amount of time each year. In 2016, workers will be required to earn $1,260 per credit.

Collecting Social Security Benefits

The amount of your Social Security benefit is calculated by averaging the earnings from your 35 highest income-generating years. The maximum monthly Social Security check that you can earn is $2,639 per month in 2016. To sign up for Social Security benefits, it is recommended that you apply three months prior to your retirement date. (For additional information about how and where to apply for Social Security benefits, go to

The Wobbly Three-Legged Social Security Stool

According to the Social Security Administration, "the three major elements of your retirement portfolio are benefits from pensions, savings and investments, and Social Security benefits." Just keep in mind that the Social Security Administration expects the program to be unable to meet its financial obligations beginning in 2035. Simply put, the number of people taking money out of the system will be greater than the number of people putting money into it. According to statistics released by the Social Security Administration, by 2031, there will be almost twice as many older Americans than there are today, rising from the current 37 million to 71 million over that period. (For more on the future, see How Secure Is Social Security?)

At present, the government's solution for addressing this imbalance is to raise the retirement age, delaying payouts to younger workers. While past generations could enjoy full eligibility for Social Security at age 65, everyone born after 1937 must adhere to the following eligibility requirements:

Year of Birth Full (normal) Retirement Age
1937 or earlier 65
1938 65 and 2 months
1939 65 and 4 months
1940 65 and 6 months
1941 65 and 8 months
1942 65 and 10 months
1943-1954 66
1955 66 and 2 months
1956 66 and 4 months
1957 66 and 6 months
1958 66 and 8 months
1959 66 and 10 months
1960 and later 67

In addition to delayed benefit eligibility in a Social Security system that is running out of money, younger workers face challenges on another front – corporate-sponsored defined-benefit plans. These plans are closing down their offerings at a record pace. They are being replaced by defined-contribution plans, which offer no guaranteed payout, rely on the stock and/or bond markets to produce gains and must be funded by the employee, sometimes augmented by employer matching contributions. (For additional information, see The Demise Of The Defined-Benefit Plan.)

Plan for Your Retirement

According to the Social Security Administration, Social Security was never designed to serve as the sole source of a retiree's income. The Administration notes that "Social Security replaces about 40% of an average wage earner's income after retiring, and most financial advisors say retirees will need about 70-80% of their work income to live comfortably in retirement." (For further reading, see Determining Your Post-Work Income.)

With the future shape of the Social Security system in flux and defined-benefit plans disappearing at an alarming pace, the best way to achieve a secure retirement is to take matters into your own hands. This means making sure to take advantage of a 401(k) or similar tax-advantaged retirement plan, if your employer offers one, or investing in an IRA or other vehicle. For more information, see The Basics of a 401(k) Retirement Plan and Roth vs.Traditional IRA: Which Is Right for You?

Advocates of so-called "private savings accounts" have gone so far as to suggest abandoning the Social Security system altogether and eliminating the FICA tax. Instead of sending 6.2% of their income to the government to support existing retirees, current members of the workforce would keep that money, giving them the opportunity to invest it on their own – theoretically, in an investment that has the potential to deliver better returns than those typically provided by Treasury bonds. The tradeoff: If those investments don't end up doing well, future retirees would have lost the guaranteed check Social Security delivered. (Check out Why is retirement easier to afford if you start early? and Delay In Saving Raises Payments Later On.)

The Bottom Line

While the final chapter in the Social Security saga has yet to be written, one thing is for certain: planning for your retirement is a good idea. If you reach retirement and other sources of income, such as Social Security and defined-contribution plans, are still available to provide income, your personal savings will add to the mix and you'll have more money than you need. If you reach retirement and those other sources of income are no longer available, you'll still be able to rely on the nest egg that you built on your own.

For more on retirement planning, read Fundamentals Of A Successful Savings Program and Retirement Planning Basics.

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