Too High For Our Own Good

For the longest time, I’ve wondered whether Social Security is a dependable source of income for traditional retirees. As someone still over 22 years away from being able to collect, it’s hard to believe in the system given it is already underfunded by ~22%.

Therefore, when the Social Security Administration announced the cost of living adjustment (COLA) for 2022, I was shocked! Due to rising inflation, there will be a COLA of a whopping 5.9%! The increase will translate to an addition of $92 to retirees’ average monthly benefit next year.

Earning $1,657 a month or $19,884 a year from Social Security until death is not bad. Further, the maximum Social Security benefit increases from $3,148 in 2021 to $3,345 in 2022.

The average person would need about $500,000 in capital returning 4% to generate $19,884 a year. In other words, we can make the assumption that the average American retiree is a half-millionaire.

As a result, I have no doubt the majority of Financial Samurai readers will be millionaires in retirement as well.

Largest Social Security COLA Since 1982

All this time, I had thought Social Security would not pay out its fully promised amount. For it to now pay such a huge cost-of-living adjustment is baffling since larger payments reduce the plan’s financial health.

The Social Security Board of Trustees recently said the trust fund that pays benefits is projected to become depleted by 2034, a year earlier than estimated in 2020. At that time, Social Security income would be sufficient to pay about 78% of scheduled benefits.

This 5.9% cost-of-living adjust will be the largest since 1982, according to Social Security Administration data. The adjustment is based on the difference between the CPI-W index’s average for the third quarter of the current year compared with the same period in the previous year.

For those of you who still have to pay a Social Security tax (FICA tax), the maximum amount of earning subject to the tax will increase to $147,000 in 2022 from $142,800 in 2021. Curiously, that equates to only a 2.94% increase versus the 5.9% COLA increase.

If the government wanted to improve the financial health of Social Security, it would at least raise the maximum taxable income limit by 5.9% as well. Although not a popular move, raising the income tax limit by 10% – 20% to $157,080 – $171,360, while capping maximum benefits, probably would have passed critical eyes.

FICA Tax Rate Revisited

FICA stands for Federal Insurance Contributions Act. It consists of a Social Security tax and a Medicare tax that automatically gets deducted from your paycheck.

The Social Security tax rate is 12.4% – 6.2% is withheld from the employer and 6.2% is withheld from the employee.

The Medicare tax rate is 2.9% – 1.45% withheld from the employer and 1.45% withheld from the employee.

Therefore, for regular employees, you will pay 7.45% of your income up to the maximum limit ($147,000) in FICA taxes.

If you are self-employed, you must pay the full 15.3%, but you can take a deduction for half this amount. Paying the full 15.3% FICA tax is one of the reasons why many small business owners elect to form S-Corps.

Let’s say you have an S-Corp and have gross profits of $147,000. To simplify, your only operating expense is income. If you pay yourself a “reasonable wage” of $47,000 and $100,000 in distributions, you get to save $15,300 in FICA tax ($100K X 15.3%).

Unfortunately or fortunately, there is no maximum income limit on Medicare tax. You’ll just have to keep on paying the 1.45% Medicare tax for as high as your income will go. Further, there is an additional Medicare tax of 0.9% for high-income taxpayers with earned income of more than $200,000 ($250,000 for married couples filing jointly).

Could Retirees Really Do Fine With Social Security?

One of the interesting potential scenarios about a 5.9% COLA increase is that inflation might prove to be temporary in 2022. For example, what if all supply-side issues get resolved by the beginning of the year? Then inflation actually settles down to the Fed’s long-term target of 2%? In such a scenario, retirees actually benefit even more.

We know that consumer prices have risen quickly due to trillions of dollars of economic stimulus. Everything from food to new cars, to home prices have skyrocketed in value.

However, if you’re a retiree who has a paid-off home, has no need for a new car, eats moderately, and doesn’t spend much on clothes, does inflation really matter?

Personally, I’m simply going to consume less during a supply-shock scenario. I’ll get the latest hit toy for my kids next year when it’s half off. Or, they’ll just have to play with cardboard boxes.

After 40+ years of saving and investing, inflation has done a wonderful job at inflating your stocks, real estate, private investments, and alternative investments. In 2020 and 2021 alone, retirees have seen their assets inflate by double-digit percentages in both years.

Therefore, providing an additional 5.9% COLA adjustment is icing on an already massive cake.

It is the person who is still paying FICA tax and still decades away from a traditional retirement age that probably needs more help. Not the absolute richest generation in our earth’s history.

Related: When Work No Longer Matters Thanks To Solid Investment Returns

Wealth By Generation Charts

Take a look at the below chart by the Federal Reserve that highlights the percentage of total net worth by generation. The Baby Boomers, those born between 1946 – 1964, are the dominating generation.

Millennials, those born between 1981 – 1996, barely have any wealth. Yet, the government has decided to give Boomers a 5.9% COLA increase despite an already underfunded pension plan? Wow!

Wealth by generation to show why Social Security COLA shouldn't be raised for Boomers

Below is another wealth by generation chart from the Federal Reserve, just constructed differently. Sure, the Millennial cohort is obviously younger than the other two cohorts and should be less wealthy. But there are more Millennials than Boomers now. If the government really wanted to properly redistribute wealth, it would focus more on helping the poorer generations.

Giving a 5.9% COLA increase to Baby Boomers is like elite private universities giving full-ride scholarships to Barack Obama’s and Donald Trump’s kids. Instead, wouldn’t it be better for universities to give scholarships to poorer families struggling to get out of the poverty cycle? I think so.

But as we found out from the latest college rankings by Forbes, Harvard’s share of Pell students is just 12% versus 25% on average for students enrolled in Forbes’ top 600 colleges. In other words, the rich like to take care of their own even though they speak differently in public.

Given the government is run by the rich, taking from the poor to give to the richest generation is par for the course.

U.S. household wealth by age of generation's median cohort and a discussion on Social Security for the wealthy

Don’t Rely On Any Social Security For Retirement

Given the government’s logic of:

  1. Raising COLA by 5.9%, but only raising the maximum income subject to FICA tax by 2.94%
  2. Helping the rich more than the poor

It’s only rational for us to continue to not rely on Social Security for retirement. If the government wanted to fix Social Security, it would do the opposite of the two things above. Raising COLA by 5.9% lowers our chances of being made whole when it’s our time to collect.

Therefore, we need to rely on the new three-legged stool for retirement:

  1. tax-advantaged retirement accounts
  2. taxable investment accounts
  3. side hustles

If Social Security is there for us when we’re in our late 60s or 70s, fantastic. If not, it doesn’t matter because we didn’t rely on it to fund our needs in the first place.

Population by age / generation in America

The sad truth is, about a quarter of seniors 65 and older rely on Social Security benefits for 90% or more of their income, an AARP analysis of Census Bureau data found. It behooves all of us to NOT end up being in this bucket of people.

The more of us who can be financially self-reliant, the more the government can do to help those truly in need. Medical care and prescription drugs will likely continue to go up at a much faster rate of inflation.

However, if the government’s logic continues unchanged, we, the self-reliant, might actually be the biggest beneficiaries of the government’s decisions in our golden years. How ironic is that?

If in doubt, retire rich. Not only will you be able to take care of yourself, the government may give you more money too.

Questions And Recommendations

Readers, what do you think about the government’s decision to raise COLA by a record 5.9% for 2022? Are you excited that once you’re rich, you too, will also get a large COLA increase?

To manage your finances, sign up for Personal Capital, the best free financial app to track your net worth, cash flow, and projected retirement income. I’ve used Personal Capital since 2012 to manage our complicated net worth and it has helped tremendously.

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Related: The Ideal Age To Take Social Security

Too High For Our Own Good is written by Financial Samurai for

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