Social Security will go down as one of the most important social programs in U.S. history. For millions of Americans, it's their financial lifeline in retirement, providing guaranteed income during people's golden years.
As we near the end of 2023, it's never too early to start understanding and planning for upcoming changes to Social Security and how much it may impact your planning. For more than 66 million Americans receiving Social Security retirement benefits in 2024, an increase to their monthly payout is on the way.
Despite the planned increase, there's a growing concern that it may not be enough to keep up with rising costs of living and expected retirement expenses for many people. This highlights the need for additional retirement planning strategies.
Image source: Getty Images.
How the Social Security COLA works
The downside to fixed income is that inflation happens, but your income remains unchanged. Receiving $1,000 monthly went much further in 2000 when the average price for a dozen eggs was $0.91 instead of the $3 or more I routinely see nowadays. Remember when movie tickets cost a few bucks? Ahh, the good ol' days.
To account for Social Security benefits losing their purchasing power over time because of inflation, Social Security introduced the cost-of-living adjustment (COLA). The Social Security COLA is meant to somewhat offset the effects of inflation.
To determine just how much to increase benefits each year, Social Security compares the third-quarter Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) results from the previous year. For example, CPI-W data from the third quarter of 2022 was compared to 2023's data to determine the 3.2% boost Social Security benefits will see in 2024.
| Month | 2022 CPI-W Data | 2023 CPI-W Data |
|---|---|---|
| July | 292.219 | 299.899 |
| August | 291.629 | 301.551 |
| September | 291.854 | 302.257 |
Data source: Social Security Administration.
The third-quarter CPI-W averages for 2022 and 2023 were 291.901 and 301.236, respectively. The 3.2% percent increase is the 2024 COLA.
Using the 80% Rule as a baseline
The "80% rule" is a popular baseline in retirement planning for deciding how much you may need annually. It suggests that retirees will need about 80% of their pre-retirement income to maintain their lifestyle in retirement. For example, if you were earning $100,000 annually before retirement, you'd aim to have $80,000 per year in retirement.
It's more of a baseline than a hard rule because you should use your personal situation and adjust the 80% accordingly. Someone living modestly now but planning to travel the world in retirement might increase the percentage; someone leaving New York City to live on a ranch in Montana might decrease the percentage.
No percentage works for everyone, but 80% is a good benchmark. Here's how much someone would need following that guidance:
| Current Annual Income | Needed Annually in Retirement | Needed Monthly in Retirement |
|---|---|---|
| $40,000 | $32,000 | $2,666 |
| $60,000 | $48,000 | $4,000 |
| $80,000 | $64,000 | $5,333 |
| $100,000 | $80,000 | $6,666 |
| $120,000 | $96,000 | $8,000 |
Source: Author calculations.
The COLA is key, but it likely can't do it alone
With the COLA, the average Social Security monthly retirement benefit in January 2024 will be $1,907. That's just over $22,800 annually, meaning it would only suffice for someone whose income is around $28,500 if we work backward from the 80% rule.
Even the maximum benefit -- $4,873 per month for 2024 -- would only work for someone whose annual income is around $73,000. For perspective, the median-household income (not single-person income) in 2022 was $74,580, according to the U.S. Census Bureau.
The gap between retirement expenses and Social Security benefits is why it's important to approach retirement planning from multiple angles. Retirement accounts like 401(k)s and IRAs can provide great supplemental income and fill in the gaps that Social Security alone can't cover. Everyone may not have access to a 401(k) because they're offered through employers, but anyone can open an IRA with earned income.
The importance of diversifying retirement income cannot be overstated. By combining Social Security, personal savings, retirement accounts, and investments, retirees can create a more secure financial foundation for their later years.
