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What to know as record 8.7% Social Security COLA goes into effect

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As inflation has kept prices high in 2022, Social Security beneficiaries may look forward to a record high cost-of-living adjustment in 2023.

“Your Social Security benefits will increase by 8.7% in 2023 because of a rise in cost of living,” the Social Security Administration states in the annual statements it is currently sending to beneficiaries.

The 8.7% increase will be the highest in 40 years. It is also a significant bump from the 5.9% cost-of-living increase beneficiaries saw in 2022.

The increase is “kind of a double-edged sword,” according to Jim Blair, a former Social Security administrator and co-founder and lead consultant at Premier Social Security Consulting, which educates consumer and financial advisors on the program’s benefits.

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“It’s good for people on Social Security,” Blair said. “It’s not so good for the economy with inflation.”

Social Security benefit checks will reflect the increase starting in January.

The average retiree benefit will go up by $146 per month, to $1,827 in 2023 from $1,681 in 2022, according to the Social Security Administration The average disability benefit will increase by $119 per month, to $1,483 in 2023 from $1,364 in 2022.

What’s more, standard Medicare Part B premiums will go down by about 3% next year to $164.90, a $5.20 decrease from 2022. Medicare Part B covers outpatient medical care including doctors’ visits.

Monthly Part B premium payments are often deducted directly from Social Security checks. Due to the lower 2023 premiums, beneficiaries are poised to see more of the 8.7% increase in their monthly Social Security checks.

“The good news about these letters is people are realizing 100% of the 8.7% lift,” said David Freitag, a financial planning consultant and Social Security expert at MassMutual.

“Of course, the economy is inflated at a frightful rate, but this represents the value of cost-of-living adjusted benefits from Social Security,” Freitag said.

Few other income streams in retirement offer cost-of-living adjustments, he noted.

What to look for in your Social Security statement

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If you’re wondering how much more you stand to see in your checks, the personalized letter from the Social Security Administration will give you a breakdown of what to expect.

That includes your new 2023 monthly benefit amount before deductions.

It will also tell you your 2023 monthly deduction for premiums for Medicare Part B, as well as Medicare Part D, which covers prescription drugs.

The statement will also show your deduction for voluntary tax withholding.

The good news about these letters is people are realizing 100% of the 8.7% lift.

David Freitag

financial planning consultant and Social Security expert at MassMutual

After those deductions, the statement shows how much will be deposited into your bank account in January.

Of note, you do not necessarily have to be receiving Social Security checks now to benefit from the record 2023 increase, Blair noted.

“The good news is you don’t have to apply for benefits to receive the cost-of-living adjustment,” Blair said. “You just have to be age 62 or older.”

When you may pay Medicare premium surcharges

If your income is above a certain amount, you may pay a surcharge called an income related monthly adjustment amount, or IRMAA, on Medicare Parts B and D.

This year, that will be determined by your 2021 tax returns, including your adjusted gross income and tax-exempt interest income. Those two amounts are added together to get your modified adjusted gross income, or MAGI.

In 2023, those IRMAA premium rates kick in if your modified adjusted gross income is $97,000.01 or higher and you filed your tax return as single, head of household, qualifying widow or widower or married filing separately; or $194,000.01 or higher if you are married and filed jointly.

Notably, just one dollar over could put you in a higher bracket.

“It’s important for everyone to make sure that the amount of adjusted gross income that they’re using for the IRMAA surcharges agrees with what they filed on their tax return two years ago,” Freitag said.

If the information does not match, you “absolutely need to file an appeal,” he said.

Because the IRMAA surcharges can be extremely significant, that is an area to watch for errors, Freitag said.

When to appeal your Medicare surcharges

If your income has gone down since your 2021 tax return, you can appeal your IRMAA.

That goes if you have been affected by a life changing event and your modified adjusted gross income has moved down a bracket or below the lowest amounts in the table.

Qualifying life changing events, according to the Social Security Administration, include marriage; divorce or annulment; death of a spouse; you or your spouse reduced your work hours or stopped working altogether; you or your spouse lost income on from property due to a disaster; you or your spouse experienced cessation, termination or reorganization of an employer’s pension plan; or you or your spouse received a settlement from an employer or former employer due to bankruptcy, closure or reorganization.

To report that change, beneficiaries need to fill out Form SSA-44 with appropriate documentation.

How higher benefits could cost you

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As your Social Security income goes up with the 8.7% COLA, that may also push your into a different IRMAA or tax bracket, Freitag noted.

That calls for careful monitoring of your income, he said.

Keep in mind that two years in the future you may get exposed to IRMAA issues if you’re not careful.

In addition, more of your Social Security benefits may be subject to income taxes. Up to 85% of Social Security income may be taxed based on a unique formula that also factors in other income.

It is a good idea to have taxes withheld from Social Security benefits in order to avoid a tax liability when you file your income tax returns, according to Marc Kiner, a CPA and co-founder of Premier Social Security Consulting.

“Do it as soon as you can,” Kiner said of filling out the voluntary withholding request form.

To better gauge how IRMAA or taxes on benefits may affect you going forward, it may help to consult a tax advisor or CPA who can help identify tax-efficient strategies, Freitag said.

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Social Security COLA will be 8.7% in 2023, highest increase in 40 years

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Amid record high inflation, Social Security beneficiaries will get an 8.7% increase to their benefits in 2023, the highest increase in 40 years.

The Social Security Administration announced the change on Thursday. It will result in a benefit increase of more than $140 more per month on average starting in January.

The average Social Security retiree benefit will increase $146 per month, to $1,827 in 2023, from $1,681 in 2022.

The Senior Citizens League, a non-partisan senior group, had estimated last month that the COLA could be 8.7% next year. 

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The confirmed 8.7% bump to benefits tops the 5.9% increase beneficiaries saw in 2022, which at the time was the highest in four decades.

The last time the cost-of-living adjustment was higher was in 1981, when the increase was 11.2%.

Next year’s record increase comes as beneficiaries have struggled with increasing prices this year.

“The COLAs really are about people treading water; they’re not increases in benefits,” said Dan Adcock, director of government relations and policy at the National Committee to Preserve Social Security and Medicare.

“They’re more trying to provide inflation protection so that people can maintain their standard of living,” Adcock said.

How much your Social Security check may be

Beneficiaries can expect to see the 2023 COLA in their benefit checks starting in January.

But starting in December, you may be able to see notices online from the Social Security Administration that state just how much your checks will be next year.

Two factors — Medicare Part B premiums and taxes — may influence the size of your benefit checks.

The standard Medicare Part B premium will be $5.20 lower next year — to $164.90, down from $170.10. Those payments are often deducted directly from Social Security benefit checks.

“That will mean that beneficiaries will be able to keep pretty much all or most of their COLA increase,” Mary Johnson, Social Security and Medicare policy analyst at The Senior Citizens League, told CNBC.com this week.

That may vary if you have money withheld from your monthly checks for taxes.

To gauge just how much more money you may see next year, take your net Social Security benefit and add in your Medicare premium and multiply that by the 2023 COLA.

“That will give you a good idea what your raise will be,” said Joe Elsasser, an Omaha, Nebraska-based certified financial planner and founder and president of Covisum, a provider of Social Security claiming software.

How the COLA is tied to inflation

The COLA applies to about 70 million Social Security and Supplemental Security Income beneficiaries.

The change is based on the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W.

The Social Security Administration calculates the annual COLA by measuring the change in the CPI-W from the third quarter of the preceding year to the third quarter of the current year.

Benefits do not necessarily go up every year. While there was a record 5.8% increase in 2009, the following two years had 0% increases.

“For seniors, because they spend so much on health care, those years were difficult,” Adcock said.

A similar pattern may happen if the economy goes into a recession, according to Johnson.

What the COLA means if you haven’t claimed benefits yet

If you decide to claim Social Security benefits, you will get access to the record-high COLA.

But you will also have access to it if you wait to start your benefit checks at a later date, according to Elsasser.

If you’re 62 now and don’t claim, your benefit is adjusted by every COLA until you do.

The amount of the COLA really should not influence claiming.

Joe Elsasser

CFP and president of Covisum

What’s more, delaying benefits can increase the size of your monthly checks. Experts generally recommend most people wait as long as possible, until age 70, due to the fact that benefits increase 8% per year from your full retirement age (typically 66 or 67) to 70. To be sure, whether that strategy is ideal may vary based on other factors, such as your personal health situation and marital status.

“The amount of the COLA really should not influence claiming,” Elsasser said. “It doesn’t hurt you or help you as far as when you claim, because you’re going to get it either way.”

How a record-high increase may impact Social Security’s funds

Social Security’s trust funds can pay full benefits through 2035, the Social Security Board of Trustees said in June.

At that time, the program will be able to pay 80% of benefits, the board projects.

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The historic high COLA in 2023 could accelerate the depletion of the trust funds to at least one calendar year earlier, according to the Committee for a Responsible Federal Budget.

Higher wages may prompt workers to contribute more payroll taxes into the program, which may help offset that. In 2023, maximum taxable earnings will increase to $160,200, up from $147,000 this year.

What could happen to future benefit increases

While 2023 marks a record high COLA, beneficiaries should be prepared for future years where increases are not as high.

If inflation subsides, the size of COLAs will also go down.

Whether the CPI-W is the best measure for the annual increases is up for debate. Some tout the Consumer Price Index for the Elderly, or CPI-E, as a better measure for the costs seniors pay. Multiple Democratic congressional bills have called for changing the annual increases to that measure.

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Here’s why the $39 trillion U.S. retirement system gets a C+ grade

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The U.S. retirement system may seem flush — yet it ranks poorly in relation to those in other developed nations.

Collectively, Americans had more than $39 trillion in wealth earmarked for old age at the end of 2021, according to the Investment Company Institute.

However, the U.S. places well outside the top 10 on various global retirement rankings from industry players, such as the Mercer CFA Institute Global Pension Index and Natixis Investment Managers 2021 Global Retirement Index.

According to Mercer’s index, for example, the U.S. got a “C+.” It ranked No. 17 on Natixis’ list.  

Here’s why the U.S. falls short, according to retirement experts.

The U.S. has a ‘patchwork retirement design’

Iceland topped both lists. Among other factors, the country delivers generous and sustainable retirement benefits to a large share of the population, has a low level of old-age poverty, and has a higher relative degree of retirement income equality, according to the reports, which use different methodologies.

Other nations, including Norway, the Netherlands, Switzerland, Denmark, Australia, Ireland and New Zealand, also got high marks. For example, Denmark, Iceland and the Netherlands each got “A” grades, according to Mercer’s index.

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Where the U.S. largely lags behind those countries, experts said, is that its retirement system isn’t set up so that everyone has a chance at a financially secure retirement.

“Even though we have $40 trillion invested, it’s a very uneven, fragmented, patchwork retirement design that we work with in the U.S.,” said Angela Antonelli, executive director of the Center for Retirement Initiatives at Georgetown University. “Some people do very, very well but a lot of other people are left behind.”

Consider this statistic: Just three of the 38 countries in the Organization for Economic Co-operation and Development rank worse than the U.S. in old-age income inequality, according to the bloc of developed countries.  

Indeed, poverty rates are “very high” for Americans 75 years and older: 28% in the U.S. versus 11%, on average, in the OECD.

Many Americans don’t have workplace retirement plans

The U.S. retirement system is often called a “three-legged stool,” which consists of Social Security, workplace arrangements such as pensions and 401(k) plans, and individual savings.

One of the structure’s primary shortfalls is a lack of access to workplace savings plans, according to retirement experts.

Just over half — 53% — of U.S. workers had access to an employer-sponsored retirement plan in 2018, according to a recent estimate by John Sabelhaus, a senior fellow at the Brookings Institution and adjunct research professor at the University of Michigan. That’s an improvement from nearly 49% a decade earlier, he found.

Even though we have $40 trillion invested, it’s a very uneven, fragmented, patchwork retirement design that we work with in the U.S.

Angela Antonelli

executive director of the Center for Retirement Initiatives at Georgetown University

Approximately 57 million Americans fell in the retirement savings coverage “gap” in 2020, meaning they didn’t have access to a workplace plan, according to a Center for Retirement Initiatives analysis.

The U.S. has a voluntary retirement savings system. The federal government doesn’t require individuals to save, or businesses to offer a pension or 401(k). Individuals also shoulder more personal responsibility to build a nest egg as businesses have largely transitioned away from pension plans.

By contrast, 19 developed nations require some level of coverage, by mandating businesses offer a retirement plan, that individuals have a personal account, or some combination of the two, according to OECD data. In 12 of the countries, the arrangements cover more than 75% of the working-age population. In Denmark, Finland and the Netherlands, for example, the share is near 90% or more.

In Iceland, where coverage is 83%, the private-sector retirement system “covers all employees with a high contribution rate that leads to significant assets being set aside for the future,” Mercer wrote.

IRAs aren’t a catchall for workers without a 401(k)

Of course, people in the U.S. can save for retirement outside the workplace — in an individual retirement account, for example — if their employer doesn’t offer a retirement plan.

But that often doesn’t happen, Antonelli said. Just 13% of households contributed to a pre-tax or Roth IRA in 2020, according to the Investment Company Institute.

IRAs held nearly $14 trillion in 2021, almost double the $7.7 trillion in 401(k) plans. But most IRA funds aren’t contributed directly — they were first saved in a workplace retirement plan and then rolled into an IRA. In 2019, $554 billion was rolled into IRAs — more than seven times the $76 billion contributed directly, according to ICI data.

Lower annual IRA contribution limits also mean individuals can’t save as much each year as they can in workplace plans.  

Americans are 15 times more likely to stash away retirement funds when they can do so at work via payroll deduction, according to AARP.

“Access is our No. 1 issue,” Will Hansen, chief government affairs officer at the American Retirement Association, a trade group, said of workplace retirement savings. Employees of small businesses are least likely to have a 401(k) available, he added.

“[However], the retirement system is actually a good system for those who have access,” Hansen said. “People are saving.”

But the retirement security offered by that savings is tilted toward high-income households, according to federal data.

Low earners, by contrast, “appear more prone to having little or no savings in their [defined contribution] accounts,” the Government Accountability Office wrote in a 2019 report. A 401(k) plan is a type of defined contribution plan, whereby investors “define,” or choose, their desired savings rate.

Just 9% of the bottom quintile of wage earners have retirement savings, versus 68% of middle-income earners and 94% of the top quintile, according to a Social Security Administration report from 2017.

Overall savings are also “constrained” by low wage growth after accounting for inflation and increasing out-of-pocket costs for items such as health care, the GAO said. Longer lifespans are putting more pressure on nest eggs.

Social Security has some structural issues

Social Security benefits — another “leg” of America’s three-legged stool — help make up for a shortfall in personal savings.

About a quarter of senior households rely on these public benefits for at least 90% of their income, according to the Social Security Administration. The average monthly benefit for retirees is about $1,600 as of August 2022.

“That doesn’t put you much above the poverty level,” Antonelli said of Social Security benefits for people with little to no personal savings.

There are also some looming structural issues with the Social Security program. Absent measures to shore up its financing, benefits for retirees are expected to fall after 2034; at that point, the program would be able to pay just 77% of scheduled payments.

Further, individuals can raid their 401(k) accounts in times of financial distress, causing so-called “leakage” from the system. This ability can infuse much-needed cash into struggling households in the present, but may subject savers to a shortfall later in life.

The “leakage” factor, coupled with relatively low minimum Social Security benefits for lower earners and the projected shortfall of the Social Security trust fund, “will have a significant impact on the ability for the U.S. pension system to adequately provide for its retirees in the future,” said Katie Hockenmaier, U.S. defined contribution research director at Mercer.

‘There’s been a tremendous amount of progress’

Of course, it can be tough to compare the relative successes and failures of retirement systems on a global scale.

Each system has evolved from “particular economic, social, cultural, political and historical circumstances,” according to the Mercer report.

“It’s hard to state the U.S. is really far behind when there are so many other external policies countries make that impact their citizens and how effective their retirement will be in the long run,” Hansen said.

Flaws in health-care and education policy bleed into people’s ability to save, Hansen argued. For example, a high student debt burden or big health bills may cause an American borrower to defer saving. In such cases, it may not be fair to place primary blame on the structure of the U.S. retirement system, Hansen said.

And there have been structural improvements in recent years, experts said.

The Pension Protection Act of 2006, for example, ushered in a new era of saving, whereby employers started automatically enrolling workers into 401(k) plans and increasing their contribution amounts each year.

More recently, 11 states and two cities — New York and Seattle — have adopted programs that require businesses to offer retirement programs to workers, according to the Center for Retirement Initiatives. They can be 401(k)-type plans or a state-administered IRA, into which workers would be automatically enrolled.

Federal lawmakers are also weighing provisions — such as reduced costs relative to factors like plan compliance and a boost in tax incentives — to promote more uptake of 401(k) plans among small businesses, Hansen said.

“In the past 15 years — and now with considerations of additional reform in Secure 2.0 [legislation] — there’s been a tremendous amount of progress in recognizing there’s room for the improvement of design of our U.S. retirement system,” Antonelli said.

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High inflation points to bigger Social Security COLA in 2023

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Social Security beneficiaries could see another record cost-of-living adjustment in 2023, based on the latest government data showing persistent high inflation.

But that increase may not be enough to pare the loss in buying power recipients have experienced over the years, according to a new analysis from The Senior Citizens League, a non-partisan advocacy group.

A popular inflation measure, the Consumer Price Index for All Urban Consumers, known as the CPI-U, was up 8.3% over the past 12 months, staying near 40-year highs, according to April data released on Wednesday.

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Meanwhile, the index the Social Security Administration uses to calculate cost-of-living adjustments each year, the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W, increased by 8.9% over the last 12 months.

That points to a cost-of-living adjustment of 8.6% for 2023, based on the April data, according to The Senior Citizens League.

That is down from the group’s 8.9% COLA estimate based on March CPI data. At that time, the CPI-W had increased 9.4% over the past year.

Social Security beneficiaries saw a 5.9% bump to their monthly checks in 2022, the highest increase in about 40 years.

To be sure, a bigger cost-of-living adjustment for 2023 is not guaranteed.

To calculate the COLA each year, the Social Security Administration compares CPI-W data from the third quarter to the third quarter of the prior year.

If inflation subsides, there is the possibility of a lower adjustment, or even no increase, for next year or in 2024.

Much of that will depend on how fast the Federal Reserve’s efforts to tamp down inflation by raising interest rates takes effect, according to Mary Johnson, Social Security and Medicare policy analyst at the Senior Citizens League.

“I think the action at the Fed is going to slow things down,” Johnson said.

One possibility is inflation may become deflation, where prices start going down very rapidly, she said.

However, even another record high cost-of-living adjustment may not be enough to stop the loss of buying power people who rely on those benefits have already seen over the years.

Social Security benefits have lost 40% of their buying power since the year 2000, according to a new analysis by The Senior Citizens League.

“People who have been retired the longest have really been impacted the most, because they’ve had a cumulative effect where their COLA hasn’t been keeping up,” Johnson said.

The sharpest drop in purchasing power ever recorded by the group occurred between March of last year and this March, when it dropped 10 percentage points.

Fastest-growing costs for older Americans from March 2021 to March 2022

Item Cost in March 2021 Cost in March 2022 % Increase
1. Home heating oil $2.86 $5.13 79%
2. Gasoline (gallon) $2.86 $4.33 51%
3. Used vehicles (numeric data) 153.873 208.216 35%
4. Propane gas (gallon) $2.30 $2.98 30%
5. Eggs (dozen) $1.63 $2.05 26%
6. Bacon (lb.) $5.85 $7.20 23%
7. Oranges (lb.) $1.27 $1.48 16.5%
8. Coffee (lb.) $4.67 $5.41 16%
9. Medicare Part B premium $148.50 $170.10 14.5%
10. Ground chuck (lb.) $4.31 $4.87 13%

Source: Senior Citizens League, based on Bureau of Labor Statistics data through March.

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Social Security retirement age reaches 67. Some say it may go higher

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Many Americans eagerly look forward to a time when they can stop working and officially set their status to “retired.”

But when asked what age they anticipate that could be, there isn’t a consensus.

The average age when people say they hope to retire is 62, according to one survey.

That is also the age at which people can first claim Social Security retirement benefits, so long as they are eligible based on their work records.

However, people receive reduced benefits for claiming early. If they wait until full retirement age to claim — generally 66 or 67, depending on when they were born — they receive the full benefits which they have earned. If they wait until age 70, they stand to get an 8% per year benefit increase over their full retirement age.

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Meanwhile, the House of Representatives last week approved a retirement bill that would push out the age for required minimum distributions on certain savings accounts to 75, up from the current age of 72. That change, if it passes the Senate, would be gradually phased in by 2032.

The proposal reflects a reality that many people today are generally healthier than generations past and therefore are living and working longer, said Mark J. Warshawsky, a senior fellow at the American Enterprise Institute and former deputy commissioner for retirement and disability policy at the Social Security Administration.

“It should cascade to other official ages throughout the tax code and the government’s programs, Social Security included,” Warshawsky said.

To be sure, no imminent changes to the Social Security program are in the works.

“It has and will continue to be the third rail of politics because of the public sensitivity around the issue,” said Shai Akabas, director of economic policy at the Bipartisan Policy Center.

That does not mean there is no urgency around the issue, however.

The trust funds that the Social Security Administration relies on to pay benefits are projected to become depleted in 2034. At that time, 78% of promised benefits will be payable, the government agency said last year.

To shore up the program, lawmakers have a choice of increasing taxes on benefits, raising payroll taxes or increasing the retirement age. Any enacted changes could include a combination of all three.

Of note, Social Security advocates are staunchly against tweaking the Social Security retirement ages.

“An increase in the full retirement age is just a benefit cut,” said Joe Elsasser, founder and president of Covisum, a provider of Social Security claiming software.

How the retirement age could change

President Ronald Reagan signs the Social Security Act Amendment into law on April 20, 1983.

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Retirement ages were last altered in 1983 under then-President Ronald Reagan.

Those changes, which raised the full retirement age to 67 from 65, are still being phased in today.

Even just the bump up to age 66 from 65 represented a 5% benefit cut, Elsasser noted.

Many experts expect that any future changes could push up the Social Security retirement age. Notably, the Social Security 2100 Act: A Sacred Trust, introduced by Rep. John Larson, D-Conn., last year, would leave those thresholds unchanged and, in some respects, make benefits more generous. But the legislation has a five-year timeframe.

Separately, the Social Security Administration has scored the financial effects other proposals to change the age thresholds could have on the program.

Just in 20 years, we’ve seen a substantial increase in the retirement age.

Mark J. Warshawsky

senior fellow at the American Enterprise Institute

“I expect that at some point in the not too distant future, Congress will agree on a Social Security package that includes some type of adjustment to the retirement age,” Akabas said. “Whether that’s in two years or 10 years, it’s very difficult to predict.”

Experts say it’s possible the full retirement age could get pushed up by a year or two, which could be gradually phased in.

Additionally, lawmakers could also raise the initial age for eligibility for retirement benefits from 62, as well as the highest age for delaying benefits and earning benefit increases from 70.

Adjustments could make it so the most vulnerable — those who are forced to retire at the earliest possible age — don’t see the same type of benefit reduction, Akabas noted.

How to plan for future benefits

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In 2000, the average age at which people retired was roughly 61 or 62. Two decades later, it’s around 66, according to government data, Warshawsky said.

“Just in 20 years, we’ve seen a substantial increase in the retirement age,” Warshawsky said. “People really, really are working longer.”

Anecdotally, Elsasser said he sees more people retiring earlier than they had anticipated as their work prospects change.

That highlights the importance of planning ahead, so you anticipate whatever your retirement years bring. Admittedly, that can be tricky, given that Social Security could be susceptible to change.

If you’re 60 and up, there is less reason to worry any prospective changes would affect your benefits, Elsasser said.

But if you’re 45 to 60 years old, it’s reasonable to plan for benefit reductions of about 5%, he said. For those who are even younger, a 10% to 15% cut is possible.

Moreover, people of all ages should also plan for worst-case scenarios in which the program does reach a point where it can only pay a portion of benefits, which may prompt as much as a 24% benefit cut for retirees.

“The real importance of planning is just making sure you have all your bases covered,” Elsasser said.

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A lasting market downturn can be big risk early in your retirement

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For investors whose retirement is decades away, the stock market’s pullback should be of little concern — there’s plenty of time for your portfolio to recover before you need the money.

Yet if you are a new retiree or on the verge of retiring, it’s worth considering what a prolonged dip would mean for your portfolio over the long-term.

Basically, down markets can pose significant “sequence of returns” risk in the early years of retirement. That risk basically is about how the order, or sequence, of stock returns over time — combined with your portfolio withdrawals — can impact your balance down the road.

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“If there’s a downturn early on, it can derail a whole retirement plan,” said Wade Pfau, a professor of retirement income at the American College of Financial Services.

The major indexes have had a rough week. Through Thursday’s close, the S&P 500 index has shed 3.9%, the Dow Jones industrial average is off roughly 3.4% and the Nasdaq composite index has slid 4.9%. Year to date, the S&P has lost 5.9%, and the Dow and Nasdaq have dropped 4.4% and 9.5%, respectively.

Generally, down markets can present a buying opportunity for investors because they’re purchasing stock at a lower price than they would have otherwise.

However, it also means that if you sell, you’re doing so at depressed prices. And for retirees especially, that can be problematic.

“If there’s a big loss in the market and you’re taking withdrawals, you could be taking more from your portfolio than what it can make up for,” said certified financial planner Avani Ramnani, managing director at Francis Financial in New York.

“If that happens early in retirement … the recovery may be very weak and put you in danger of not recovering at all or being lower than where you would have been and therefore jeopardizing your retirement lifestyle,” Ramnani said.

Here’s how a sequence of returns risk can impact your savings: Say a person had retired at the turn of the century with $1 million invested in the S&P and withdrew $40,000 each year, with withdrawals after the first year adjusted 2% for inflation.

In 2020, the remaining balance would have been about $470,000, according to Ben Carlson, director of institutional asset management for Ritholtz Wealth Management, who crunched the numbers for a blog post.

In the above scenario, the portfolio would have been subject to a bear market at the outset of the person’s retirement, when the S&P lost 37% over three years during 2000-2002, but enjoyed a long-running bull market that began in 2009.

It’s not the specific returns over time but the order of those returns that matter.

Wade Pfau

Professor of retirement income at the American College of Financial Services

However, if the order of yearly returns were flipped — the gains posted by the S&P at the end of the 20 years happened first and that early bear market happened last — that same person would have more than $2.3 million after withdrawing the $40,000 or inflation-adjusted amount each year.

“It’s not the specific returns over time but the order of those returns that matter,” Pfau said.

How to combat the risk

The good news is that there are options for mitigating the risk.

The first is to simply plan to spend more conservatively, Pfau said. In other words, the less you spend consistently, the less you have to withdraw overall.

Another strategy is to adjust your spending when your portfolio performance is suffering. 

“You look at your expenses and see if there are any you can stop,” Ramnani said. “So maybe you don’t take a trip, or you delay doing a large renovation that would require a big distribution.”

You also can actively reduce risk in your portfolio, Pfau said. For instance, you could have a low stock allocation early in retirement but increase it over time, or use bonds for short-term expenses and stocks for long-term ones.

“You’re strategically reducing volatility,” Pfau said.

The last option is to have assets outside your investment portfolio that can support your spending needs when stocks are underperforming.

“You would use that as a temporary resource while you wait for your portfolio to recover,” Pfau said. 

He said that buffer could be cash, a reverse mortgage line of credit or permanent life insurance with a cash value, assuming it’s protected from market losses.

Additionally, given how well the market has generally performed over the last decade, you may simply be able to meet your goals without taking on the risk that comes with stocks.

“You could take some of that volatility off the table,” Pfau said.

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Tool shows how changes could affect you

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A Social Security Administration office in San Francisco.

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It’s no secret the funds Social Security uses to pay benefits are running low.

New proposals on Capitol Hill aim to fix the program’s solvency.

Just how dramatic those changes will need to be depends on how soon changes are put through.

Likewise, people who are planning for their retirement now may also want to make adjustments based on unforeseen events that could pop up down the line.

That includes any potential cuts to Social Security retirement benefits.

More from The New Road to Retirement:

Here’s a look at more retirement news.

“When you’re looking at all these ‘what ifs,’ the adjustments you make now in order to plan for something later are much smaller,” said Joe Elsasser, founder and president of Covisum, a Social Security claiming software company.

To that end, Covisum has developed a calculator to help both consumers and financial advisors gauge just how impactful any Social Security benefit cuts could be to their bottom line in retirement.

To be sure, benefit cuts are not a given.

One year ago on Thursday, the Social Security Administration released projections indicating its trust funds could become depleted in 2035, at which point 79% of promised benefits would be payable.

An official update is expected to be released soon with the agency’s annual trustees report. Meanwhile, other projections have already speculated that the expiration date could be sooner due to economic after effects of the Covid-19 pandemic.

To fix that shortfall, experts generally expect some changes. Benefit cuts are among the possibilities, as well as potential payroll tax increases, or a combination of both.

In 1983, when President Ronald Reagan ushered in the last major Social Security reform to fix the program’s then ailing finances, that included gradually raising the retirement age to 67 and imposing some taxes on benefits for the first time.

The key for anyone who is looking toward claiming Social Security retirement benefits now is not to base the decision on worries of what changes could be coming.

“The temptation may be to act on fear,” Elsasser said. “It’s rarely the best track for financial planning.”

“Having a realistic understanding of the impact, even in a bad case, is better than going in with your eyes closed,” he said.

Covisum’s new calculator helps advisors evaluate Social Security claiming decisions. For many people, that is the cornerstone of their retirement plan, Elsasser said.

The calculator can stress test clients’ plans against benefit cuts and other negative scenarios such as poor market performance or negative health situations to see if their plan would still be ok.

“If it is, then you don’t have to act on fear,” Elsasser said.

If it is not, then adjustments like reducing lifestyle expenses or working longer may be necessary.

There is also a free version of the calculator available to consumers.

That version requires four data points: year of birth, benefit amount at full retirement age, percentage of a hypothetical benefit cut and the year that cut occurs.

Then it compares results of a person’s lifespan in five-year increments based on how early they claim — from age 62 or as late as 70 — and how that would be impacted if benefit reductions are put in place or not.

Ultimately, the results can be a starting point for people to evaluate what the potential results could be, which will hopefully lead them to avoid claiming early — and therefore take reduced benefits for life — just because they are afraid of benefit cuts, Elsasser said.

Research indicates those cuts would likely be less than 25%, if they happen at all, he said.

Notably, the calculator does not factor in the idea that benefits could go to zero. Because current tax revenues still support the program, that’s a highly unlikely scenario, Elsasser said. Even younger generations should continue to see income from the program in the future.

“The likelihood of it going to zero is as close to zero as you can get,” Elsasser said.

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