When Social Security was first introduced in 1935, it was presented as a safety net for the unemployed, retirees, and other groups in need of a basic income. And to its credit, it's done just that. For many Americans, Social Security accounts for most, if not all, of their income.
As of Jan. 2024, the average monthly Social Security retirement benefit is expected to be around $1,907. It hasn't always been that high, though. Social Security benefits increase yearly (with some exceptions) thanks to the cost-of-living adjustment (COLA).
However, even with the COLA, there's one big issue with Social Security: It may not be enough.
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How does the COLA work?
Products and services tend to increase in price over time. Anyone responsible for managing the household finances can probably tell you about their firsthand experience with inflation.
For people on fixed incomes such as Social Security, inflation presents an even larger problem. Receiving the same amount of money each month while everything is becoming more expensive around you means you're constantly losing purchasing power, and at some point, you may not be able to sustain your lifestyle.
To offset this, Social Security increases its payouts annually to account for inflation. The administration uses the third-quarter reading of the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to determine how much to increase benefits each year.
For 2024, Social Security announced a 3.2% COLA, less than the 8.7% in 2023 and 5.9% in 2022.
Social Security may come up short in covering your expenses
Broadly prescribing how much someone needs in retirement is misleading because so many factors are in play. Someone retiring in Southern California likely won't need the same amount as someone retiring in Montana. Someone planning to spend their time traveling likely won't need the same as someone planning to spend their time locally.
However, for the sake of an example, let's take a basic approach and use the 80% rule, which says retirees should plan to have 80% of their last working year's income in retirement to maintain their current lifestyle. The 80% rule is far from foolproof, but it can provide a baseline.
With that in mind, here's how much someone might need annually in retirement based on their last working year's income:
| Current Income | Amount Needed Annually | Amount Needed Monthly |
|---|---|---|
| $40,000 | $32,000 | $2,667 |
| $60,000 | $48,000 | $4,000 |
| $80,000 | $64,000 | $5,333 |
| $100,000 | $80,000 | $6,667 |
| $120,000 | $96,000 | $8,000 |
Calculations by author. Rounded to the nearest dollar.
The average Social Security payout in Jan. 2024 will be $1,907 per month ($22,884 per year), which would only suffice for someone currently making just over $28,600 per year, based on the 80% rule. According to the U.S. Census data, the median personal income for 2022 was $48,480. That's a sizable gap.
Social Security is better served as supplemental income
The easiest way to combat the shortcomings of Social Security is to have additional sources of retirement income. It should be a multifaceted approach.
The most common retirement account is the 401(k), which is available through your employer. A 401(k) allows you to save and invest pre-tax income, lowering your tax bill for the year contributions are made. For people who don't have access to a 401(k) -- or even those who do -- IRAs make a great option as well.
There are two main types of IRAs: traditional and Roth. Traditional IRAs are similar to 401(k)s because contributions can be deducted from your taxable income, depending on your filing status, income, and whether you're covered by a work-sponsored retirement plan. Roth IRA contributions are made after taxes, but you can take tax-free withdrawals in retirement as long as you're 59 1/2 years old and make your first contribution at least five years prior.
Regardless of which option(s) you choose, it's important to start saving as early as possible and let the power of compound earnings do much of the heavy lifting for you. You can never financially over-prepare for retirement.
