There are currently only a few days left until the 2025 Social Security Cost of Living Adjustment (COLA) is announced. Also, if you’re a senior who derives most of your income from Social Security, you may want to know how much your monthly benefits will increase in the new year.
But relying on Social Security COLAs is not a great way to function in retirement. In fact, you should know that while these COLAs are designed to help seniors maintain their purchasing power as the cost of living rises due to inflation, they often fail miserably.
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Last year, the nonpartisan Alliance on Seniors revealed that Social Security recipients have lost 36% of their purchasing power since 2000. And the big reason ultimately lies in the way these COLAs are calculated.
The Social Security COLA is based on changes in the Consumer Price Index for Urban Wage and Office Workers (CPI-W). However, the CPI-W does not adequately capture costs specific to the elderly. All you need to do is read the name of that index carefully to see why.
Social security recipients are not essentially wage earners. Yes, it is possible to work and receive Social Security benefits at the same time. However, most people receiving benefits have left their jobs.
Additionally, Social Security recipients do not necessarily live in urban areas. Therefore, Social Security recipients may continue to lose purchasing power until a new method of calculating COLA is implemented.
That’s why it’s important to develop a retirement strategy that is less dependent on COLAs. Here are some ways to accomplish that.
1. Have external savings
If you have a normal income, Social Security is only worth about 40% of your pre-retirement wages. So even if the system for determining COLAs improves, it’s a good idea to have outside savings you can tap into.
By making consistent contributions to an IRA or 401(k) plan throughout your career, you can be in a much better position for savings if you invest your money in stocks that have a history of generating high returns. For example, if you contribute $400 per month for 30 years and apply an 8% annual return over that period, your portfolio could be worth about $544,000, which is a notch below the stock market average.
2. Invest in assets that provide recurring income
In addition to Social Security, it is important to have a stable income after retirement. To do this, aim to hold investments that not only have the potential to increase in value, but also provide regular payments.
Municipal bonds are a good option in this regard. These are considered fairly stable investments, and the interest paid is not subject to federal tax. REITs, or real estate investment trusts, must pay out at least 90% of their taxable income to shareholders as dividends, so you might consider holding them as seniors in your portfolio.
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3. Watch your spending
Some people spend their retirement just as they did during their working years. But that only works if you have comparable income.
If you’re thinking about having less income in retirement, that’s understandable. But it also means you may need to adjust your spending to avoid financial stress.
Consider whether you need to keep the home you’ve raised your family in, or whether it makes sense to downsize to save money. Similarly, think about where you live.
While you’re working, it may make sense to live in a larger, more expensive city because of easier access to jobs. If you’re no longer working, moving to a less expensive part of the country can potentially increase your overall retirement income.
Social Security COLAs are supposed to do good for seniors. Unfortunately, we often fail to achieve that goal. Setting yourself up to be less dependent on these COLAs can make the difference between financial security in retirement and years of money-related worries.
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“Why You Can’t Rely on a Social Security COLA in Retirement — What to Do Instead” was originally published by The Motley Fool.
