May 18, 2022
Inflation is top of mind in the investment community. As my colleague Dan Mintz discusses in his corresponding article, inflation is historically high. At Clifford Swan, we have strategies to preserve and grow our clients’ wealth in an inflationary environment. Our approach to disciplined stock picking, as described by Dan, is one of them. In addition, outside of our clients’ investment portfolios themselves, there are other tools we can employ to combat rising prices. For our senior clients in particular, Social Security benefits—which make up about one-third of income of all retirees—can be an extremely compelling hedge against inflation.
"...outside of our clients’ investment portfolios themselves, there are other tools we can employ to combat rising prices."
For all of us, inflation impacts our daily lives. It makes the goods and services we demand more expensive, and for seniors in or nearing retirement, this can be particularly worrisome. For one, rising prices mean we need to spend more on the things we need. As we plan for retirement, it’s important to project into the future how much we may need to spend. To the extent that rising inflation makes those predictions more difficult to make, and higher, inflation can undermine our confidence and our potential ability to sustain ourselves into a long retirement. Secondarily, inflation itself or fears about it could even disrupt investment markets, leading to lower investment returns.
To combat the impacts of rising inflation for seniors, Social Security is an extremely valuable tool. Social Security is an inflation hedge, with payments 100% positively correlated to inflation. This means that when inflation increases, so do Social Security benefits, and even better, if inflation decreases, benefits remain even. Benefits adjust annually for the impact of increases in consumer prices.
"...when inflation increases, so do Social Security benefits, and even better, if inflation decreases, benefits remain even."
There are several types of Social Security benefits, including benefits paid for individual retirement, disability, to a spouse/dependent children, and to surviving family members. Social Security decisions ought to consider an individual or family’s particular circumstances, including health status, life expectancy, and other financial factors as well. For the purposes of this article, we will focus upon benefits paid to individuals, based on their own work records, and we recommend that clients consult with their investment counselors when considering when and how to craft their own claiming strategy.
"...you have a choice in when to start collecting Social Security payments, and that timeline also impacts the amount of your benefit."
For individual workers, the calculation behind each of our Social Security benefits can be complicated and confusing. In general, your individual benefit is based upon your highest 35 years of wages, and you must work for 10 years to qualify for worker benefits. Furthermore, you have a choice in when to start collecting Social Security payments, and that timeline also impacts the amount of your benefit. In most scenarios, you can start collecting Social Security as early as age 62. However, collecting before your full retirement age (“FRA”), which is currently 66 or up depending on your birth year, will reduce the benefit you receive. If you wait beyond FRA, your benefit grows at a rate of 8% per year, until you reach age 70. Even in a low inflation environment, we generally recommend that, in the absence of a shorter life expectancy or other unique circumstances, clients wait to collect Social Security until age 70. The 8% per year growth is guaranteed as long as Social Security remains solvent, and that is extremely compelling. Furthermore, in an economic environment where inflation is top of mind, growing your individual benefit for as long as possible means having a larger base for Social Security’s annual COLAs (cost of living adjustments) going forward. Over time, that is even more beneficial when inflation is high or increasing. Additionally, because Social Security is only taxed on 0-85% of the benefit you receive, depending on the particulars of your finances, the inflation-indexed growth achieved by waiting to collect is even more powerful.
"...in an economic environment where inflation is top of mind, growing your individual benefit for a long as possible means having a larger base for Social Security’s annual COLAs (cost of living adjustments) going forward."
Unfortunately, the way Social Security measures inflation may not match seniors and their spending habits well. Each fall, certain months of the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPIW) are averaged together to produce Social Security’s annual COLA. In October 2021, it was determined that the COLA for 2022 benefits would be 5.9%. Importantly, annual COLAs are applied to all benefits for individuals aged 62 and older. In other words, even if you delay collecting Social Security, you are still getting the benefit of inflation-based cost of living adjustments. However, basing the COLA for retirees upon the CPI-W really reflects the impact of inflation upon a working household, not a retiree’s. For most senior households, spending might be more focused on items like healthcare, for example, and historically healthcare costs have risen by more than overall inflation itself.
"Unfortunately, the way Social Security measures inflation may not match seniors and their spending habits well."
However, despite this, we still recommend that clients consider their Social Security benefits as a powerful tool to protect against inflation and act accordingly. Your investment counselor can help you navigate your particular situation, but to maximize this inflation hedge, seniors should strongly consider waiting until age 70, but not beyond 70, to start collecting benefits. For those who might have already filed for Social Security and want to change course, it may not be too late. If you are younger than 70, but over your FRA, you may be able to suspend collecting your benefit for a period to time, to allow it to grow until you resume collecting benefits again at 70.
"For those who might have already filed for Social Security and want to change course, it may not be too late."
To summarize, we recommend that clients consider delaying collecting their Social Security benefits and consult their investment advisor for guidance. For healthy individuals, waiting until age 70 to collect has always been a compelling value proposition if you can afford to do so, and the longer you live, the more impactful waiting and growing your benefits will have been. However, in the current investment environment where inflation is especially concerning to seniors, waiting to collect Social Security and maximizing the amount of your income that is therefore inflation-indexed is especially appealing. Waiting until age 70 to collect benefits is one of the most effective inflation hedges out there for retirees.
Download Article: Social Security as an Inflation Hedge
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.