What Social Security's Paltry 2014 Raise Says About Future Benefit Increases

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.

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.