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What Social Security's 2014 Raise Should Really Tell You

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Social Security this week announced its annual cost-of-living adjustment for 2014. As predicted, the increase will be 1.5%, which translates roughly to an additional $19 per month for the typical retiree. If that seems low -- it is. That cost-of-living adjustment is tied to the rate of inflation, which has been trending lower in recent years than in the 1970s when the adjustment was first created.

If you're a Social Security recipient and it feels like your own monthly costs have increased by more than $19 over the past year, you're probably right. The inflation rate used for Social Security increases is based on the inflation felt by urban wage earners, not seniors. The key difference is health-care costs, which generally are increasing faster than overall inflation while being an expense that people typically spend more on as they age, even before considering inflation.

You're probably falling behind
No matter what the actual driver in your particular case, chances are pretty good that your monthly costs have increased more than $19 over the past year. If you're receiving the average benefit check and Social Security is your sole source of retirement income, that tiny raise is all you can expect.

Unfortunately, that story of cost-of-living adjustments below your actual cost increases is one that will likely continue well into the future. Not only is the health care cost situation likely to remain a problem, but the talk in Washington is of potentially replacing the current inflation calculation with a "chain-weighted" calculation. If implemented, chain weighting is expected to lower the inflation rate that drives the Social Security cost-of-living adjustments.

Even worse, if you're a younger Social Security recipient or haven't yet reached the age where you're eligible to collect, there's a bigger issue that goes far beyond the rate of benefit increases. The Social Security Trust Funds are on track to run out of money in 2033, cutting overall benefit levels by about a quarter. If you're in your early to mid-60s or younger, you're likely to live long enough to be affected by those cuts, which will make "chain weighting" seem easy by comparison.

Don't rely only on Social Security
Even without that long-term crisis looming, the reality is that you need more than just Social Security to retire comfortably. Per the Social Security administration itself:

Social Security was never meant to be the only source of income for people when they retire. Social Security replaces about 40 percent of an average wage earner's income after retiring, and most financial advisors say retirees will need 70 percent or more of pre-retirement earnings to live comfortably. To have a comfortable retirement, Americans need much more than just Social Security. 

The $19 monthly raise the average Social Security retiree can expect to see for 2014 is far less a problem for someone with adequate levels of other income. The problem, though, is that it takes a few decades to get enough money saved up to generate that kind of income stream.

If Social Security covers about 40% of your pre-retirement income and you need 70% to retire comfortably, you'll need to cover about 30% with other sources, such as your portfolio. Using the 4% rule for retirement withdrawals as a guide, in order to generate 30% of your pre-retirement income from your portfolio, you'd need a nest egg of about 7.5 times your annual income.

In other words, whether you're trying to make up for the emptying Trust Fund or just want to keep up with costs rising faster than $19 per month, you need a plan to cover what Social Security won't. The only way to start from scratch and get to that large of a portfolio is to work with a time frame measured in decades.

Get started now
Over the long run, the stock market has returned somewhere around 10% annually when you include the impact of reinvesting dividends. For Treasury bonds, the level is closer to 5%. Still, there are no guarantees in the market, other than the fact that if the alternative is spending the money you make, even lousy investing beats not investing at all.

The table below shows the percentage of your income you need to save each year to get to that nest egg of 7.5 times your annual income by the time you retire, based on various time frames and return rates. As you can see, the longer your time frame, the easier it is to get there, and once you get down to less than 20 years to go, the amount of your income you need to save gets impossibly high.

Years

10% Annual Return

7% Annual Return

4% Annual Return

1% Annual Return

40

1.7%

3.8%

7.9%

15.3%

35

2.8%

5.4%

10.2%

18%

30

4.6%

7.9%

13.4%

21.6%

25

7.6%

11.9%

18%

26.6%

20

13.1%

18.3%

25.2%

34.1%

15

23.6%

29.8%

37.5%

46.6%

10

47.1%

54.3%

62.5%

71.7%

Data from author's calculations.

Whether you're looking to cover for the gaps from Trust Funds' pending collapse or merely trying to cover the increasing costs that $19 more a month won't cover, you need to start now. Time can still be your ally, but only if you put money behind it to enable it to really work for you.

Even weakened, Social Security will still be there
Social Security plays a key role in your financial security, and it will continue to do so, even if the Trust Fund's empty and the cost-of-living adjustment becomes chain-weighted. In our brand-new free report, "Make Social Security Work Harder For You," our retirement experts give their insight on making the key decisions that will help ensure a more comfortable retirement for you and your family. Click here to get your copy today.


Read/Post Comments (6) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 02, 2013, at 5:38 PM, peckbill wrote:

    Maybe the feds are going to pay back the money they stole from social security????

  • Report this Comment On November 02, 2013, at 9:11 PM, redwolf wrote:

    For a huge percentage of the American population, it is too late. That is all they are going to get. They are going to have to do without food, clothing, heat and other essentials. No one will care. They were unimportant drones and they will be treated like driftwood and left to fend for themselves. Social Security was touted as an income to many boomers and they were told they would never starve since it was their money and would be distributed to them in their senior years. Many of these "Social Security only" recipients didn't make the big money or didn't work constantly because they were ill, raising a family, caring for an elderly relative or unemployed because the jobs disappeared. Stop making them feel even worse.

    Those who have money don't need this article. They are out shopping, vacationing, at health spas etc.

    The middle class is all but gone and with the rising costs of everything, most of them will fail to save what it is estimated that they will need to not have to live like serfs in a feudal system.

  • Report this Comment On November 03, 2013, at 8:19 AM, prginww wrote:

    Shhhhh! Don't bring this up too much. Paying those who depend on S.S. 1% less than inflation will give Billions to the government coffers. And those who can afford to pay more (just ask Warren Buffet who is practically begging politicians to tax him more) are handcuffed by the "pledge not to raise any taxes or we will destroy your career" folks on Capitol hill. If we don't right this ship and get, for starters, a $4 Trillion "grand bargain" of revenue increases / wasteful spending cuts spread over 10 years, heaven help us.

  • Report this Comment On November 03, 2013, at 9:43 AM, desuhu wrote:

    We knew that we were supposed to save for our own retirement and we did, but now our savings is earning practically no interest due to the Feds keeping interest rates near zero (and we know why they're doing that) so, we're losing ground every year, due to having to draw money out of our IRA'a, but not earning anything to build them. We were in the market until 2007, but grew concerned that we were running out of time to stay in for the "long haul" as financial advisors like to say. When we rolled our 401k's into IRA's, the interest rate was 5.15%, a decent amount on our money. Now, the interest rate is .50%. You cannot plan for this kind of downturn.

  • Report this Comment On November 03, 2013, at 9:46 AM, desuhu wrote:

    "redwolf", you're so right. My mother-in-law worked for 24 years at a sewing factory (her husband farmed), got no pension and only has about $600/mo. to live on now. If it weren't for her subsidized housing and help from her kids, she couldn't survive. And she is very frugal, I mean very frugal. I never saw anyone who could stretch a dollar like she can. I'm guessing that the top people at the sewing factory are drawing nice pensions now!

  • Report this Comment On December 11, 2013, at 7:29 AM, carl222 wrote:

    1.5 percent is about 2 percent less than inflation this year. in most states.

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Chuck Saletta
TMFBigFrog

Chuck Saletta has been a regular Fool contributor since 2004. His investing style has been inspired by Benjamin Graham's Value Investing strategy. Chuck also can be found on the "Inside Value" discussion boards as a Home Fool.

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