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What the 2022 Social Security Increase (5.9%) Means for Your Retirement Thumbnail

What the 2022 Social Security Increase (5.9%) Means for Your Retirement

Retirees can expect a substantial increase to their Social Security check from next year – on average $93.20 more per month (beginning with the December 2021 benefits, payable in January 2022). But this increase isn't necessarily cause for celebration, especially if you're on Medicare. Read on to discover why this is the most significant adjustment in decades, how it may affect your finances, and what actions your advisor may recommend.

Why is Social Security increasing by 5.9% in 2022? COLA explained

Social Security benefits usually experience an annual increase. This yearly boost is to keep payments in line with the cost of living. With more than 64 million beneficiaries on Social Security, there are few announcements from Social Security Administration (SSA) more eagerly anticipated or important to retirees than the annual Cost-Of-Living Adjustment (COLA).

It's fair to say the past year - with the pandemic, a recession, elections, and riots - has been a volatile one, and we're living through remarkable times. So it's perhaps no surprise that this year's announcement from the SSA revealed that the latest cost of living adjustment (COLA) is 5.9%. This is causing shockwaves because it is the most significant increase since 1983 (for comparison, the average increase across the past decade was 1.65%).

It's worth keeping in mind that while this year's COLA is indeed large, it does not take the record (which was a whopping 14.3% increase in 1981). This year's increase takes 8th-equal place in the history books (shared with 1977) since automatic yearly COLAs began in 1975. So some perspective is needed, and while this is the biggest raise many recipients will have experienced during the span of their retirement, it is not unprecedented.

So the Social Security increase is an income raise for beneficiaries?

Not quite. The purpose of COLA is to counteract the effects of inflation. It is not designed to help retirees get ahead, but instead to keep pace with rising prices for goods and services. The intention is to make sure that retirees' purchasing power - the dollar value of your benefit - remains equitable to increases at the gas pump, supermarkets, and everywhere else your dollar is spent. It's not an extra $92; it's to bridge the gap. 

To this end, COLA is harnessed to the Consumer Price Index (CPI).

How is COLA calculated? CPI-W and CPI-E explained

The Social Security Administration calculates the annual increase based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This index tracks a 'basket' of goods and services, with dozens of subcategories and relative weightings. For example, gasoline is weighted heavily in the CPI-W, which helped drive up the 2022 COLA estimate. The main eight categories are: 

  • Housing (rent or owners' equivalent)
  • Food and beverages
  • Clothing
  • Transportation
  • Medical care (incl. prescriptions)
  • Recreation (e.g., televisions, toys, pets, sports, etc.)
  • Education and communication
  • Other goods and services (e.g., tobacco, personal services, haircuts, etc.)

COLA has been calculated since 1983 by comparing the average CPI-W for the third quarter (1 July – 30 September) of the current year with the third quarter of the previous year, and adjusting according to the price increase in this predetermined basket of goods. Inflation rose in 2021 because of rising energy costs, global supply chain issues, and labor shortages caused by Coronavirus, which resulted in this 5.9% COLA.

CPI-E: a fairer measure for COLA

The CPI-W actually does a poor job of measuring the economic effects of inflation on the program's intended recipients. The COLA should maintain seniors' purchasing power, but past research has shown these calculations aren't very good. This is because the spending habits and priorities of "Urban Wage Earners and Clerical Workers" differ from those of retirees in substantial ways. For instance, a number of key categories in seniors' spending habits – food, electricity, housing, and healthcare – regularly outpace the rate of inflation accounted for by the overall measure. This disjuncture means retirees' dollars actually count for less when it comes to the goods and services they are more likely to buy with their income.

One solution to this has been proposed by Rep. John Garamendi, D-Calif., who advocates that COLAs should be based on a specific Consumer Price Index for the Elderly. However, while Garamendi introduced the Fair COLA for Seniors Act of 2021 in June (and Biden previously made it part of his election promise), results are still a long way off. As it currently stands, the situation for seniors struggling to make ends meet is that higher costs will continue to eat up the COLA boost. And that's not even factoring in deductions from the premium increases on Medicare.

What does this mean for Medicare Part B monthly premiums in 2022?

Medicare Part B monthly premiums in 2022 are estimated to increase from $148.50 to $158.50. This is a 6.7% increase. What's more, the Medicare Part D premium for drug coverage is projected to increase by 4.9% in 2022. So if you're one of the 70% of Americans whose premiums are deducted from their Social Security check, you might be surprised to not 'see' any real benefit from the COLA.

If you're already on Medicare but don't yet receive Social Security payments, the prospect of $93.20 more per month may be an added temptation to apply before reaching your full retirement age. Don't!  We've previously posted about how the age at which you begin taking your Social Security will permanently determine how much your monthly benefits will be, making it much more financially rewarding to wait until reaching your Full Retirement Age (FRA). Additionally, COLA does not keep pace with Medicare price increases. For the past two decades, the average annual Medicare Part B premium has jumped 5.9%, compared to a COLA of 2.2%.

This is another area in which CPI-E may better reflect seniors' expenses because it includes a higher weighting for healthcare. For the moment, however, recipients might be surprised how much of the $93.20 doesn't reach their wallets. COLA's take-home will seem far less than expected.

What does the Social Security increase mean for my everyday financial life?

It's important for us to be aware of how inflation will affect our day-to-day lives. Effectively, the cost of living is going up in 2022. Due to the disparity between how it is measured (CPI-W) and what retirees actually spend their income on, the COLA won't cover the difference to make ends meet.

This isn't new. A study by The Senior Citizens League in 2020 found that - even after adjustment measures - in real dollar terms, the buying power of seniors has reduced by 30% since 2000. Put another way, $100 of Social Security checks only gets you $70 worth in the same goods and services from twenty years ago. Since that study, we've seen even sharper rises.

The COLA certainly helps, but it's not a panacea. With benefits constituting about 40% of seniors' pre-retirement income levels (and retirees needing about 70-90% according to the Department of Labor to maintain their standard of living), retirees are increasingly reliant on income from their savings to keep up. The problem is, retirees tend to invest conservatively - which means their hard-earned savings continue to fall during times of high inflation. Downturns are particularly detrimental to their finances because they don't have the luxury to ride it out.

How a Fee-Only Financial Advisor can help you weather the storm

Working with a financial advisor can help you figure out how to handle retirement. You might not have all the pieces yet, but working together to plan for your future is worth every cent! It's not a booming economy right now, but inflation will lead to higher interest rates in the future. If it doesn't, there is something wrong with the market or too much intervention. Usually, this is self-correcting, but there are measures you can take:

  • Advisors might recommend changing portfolios to include inflation-protected investments (TRIPS, inflation-protected bonds, real estate, etc.)
  • Cash-out refinances could help people get more equity out of their homes as house prices go up (Real estate prices usually go up in inflationary markets).
  • Consider changing the focus of certain US investments to more inflation-focused sectors (like technology and consumer goods, or resistant commodities).

One of the most important things for retirees, or those nearing retirement, is to remain calm. Inflation should have been factored into their financial plan at an average rate per year (around 3%). While it had previously slowed down to almost 0%, it can safely climb above 3% without major concern.  Higher prices are always possible in the lead up to when you retire and need these funds later in life. Be prepared. Having plenty of cushioning means there isn't too much concern when the value of one's nest egg varies. Just wait out tough times like these and - if needed - take more money out of your portfolio to adjust for higher prices. Stay the course.