The Social Security Administration ("SSA") recently announced that it will increase benefits for retirees and disabled workers by 5.9% in 2022. While this benefits increase is a welcome change in light of continued inflation concerns, it's good to know the difference between what this increase means for recipients -- and what it doesn't mean.
Here, we'll look at a balanced view of the upcoming increase in monthly benefits from the SSA.
Why this adjustment matters
Talk within the broader financial community over the past six months has been almost singularly focused on the return of inflation. Since this past May, year-on-year inflation measures have steadily registered over 5%, which simply means that basic goods and services have increased in price by at least 5% since last year. Conversely, this means that in each of the past five months your dollars were effectively worth 5% less than they were one year ago.
Recall that one of the main goals of prudent savers is to maintain the purchasing power of their dollars; in other words, to maintain the real value of their money. In this pursuit, long-term investors want to earn a long-term return that exceeds inflation, thus maintaining their purchasing power and earning a real investment return at the same time.
For example, stock market indices, namely the S&P 500, have averaged roughly 10% in nominal pre-tax returns over the past 100 years. If the stock market gains 25% in 2021, but inflation eats away 5% of that return, the real return for the year would be approximately 20%.
Certainly a real return of 20% is one that most investors would be quite satisfied with. But imagine the market had gained only 3%? You'd lock in a negative 2% return for the year after accounting for 5% inflation. Banking on 20% returns going forward is a tenuous proposition at best, so it's still important to realize the very real effect that inflation is having on your money -- and the effect that it could have in the future.
The SSA's cost-of-living-adjustment ("COLA") acknowledges this reality by planning to bump benefit payments up by 5.9% at the start of the new year. This will help protect seniors and disabled people from the otherwise damaging effects of inflation; in other words, the COLA will help those living on a fixed income maintain their purchasing power without having to depend on other sources, like the stock market, for investment returns.
Why you should temper your expectations
From one angle, the SSA can be viewed like an insurance company: It pays benefits out based on an actuarial schedule, in large part due to the revenue it takes in via payroll tax. However, it doesn't want to increase benefits unless it feels it really needs to. The upcoming 2022 bump is the SSA's largest since 1982. That's 40 years.
The 5.9% increase is on one hand impressive, while on the other hand is what's necessary to keep people living on fixed benefits able to live at the same level as before. This means that the increase won't necessarily make retirees and disabled people better off; it will simply allow them to maintain the same standard of living they had been enjoying previously.
It's somewhat unnerving that this is what's needed to combat runaway inflation, but at the same time it is encouraging that the SSA is willing to take appropriate action. The SSA also did this in the face of a rapidly depleting trust fund reserve, which means the organization has to be especially careful about the money it pays out to those collecting its payments.
It also raises questions about the future: Is this inflationary environment transitory, as President Biden says, or is it our new normal? Only time will tell. But there are some interesting signals, like protracted supply chain disruptions and continued wage increases, that may indicate higher prices are here to stay.
The increase matters, but know what it means
The upcoming increase in Social Security benefits is good news for people receiving benefits; their respective standards of living won't decrease in 2022. But it isn't only a cause for celebration: There are real concerns at play in the broader economy, as well as on the balance sheet of the SSA. It's best to view the COLA as a respite from the unwanted effects of inflation, but it should also be acknowledged as a necessary tool the SSA has deployed to operate in a challenging economic environment.