Millions of senior citizens breathed a sigh of relief when the Social Security Administration announced that due to inflation it would be increasing payments by 3.6% in 2012 -- the first cost-of-living adjustment since 2009.
So what exactly does this increase amount to? Not a whole lot.
The average expected benefit for a retiree in January 2012 is a meager $1,229, and that's including the recent increase. That works out to $14,748 a year, or a bit more than $7.37 an hour for a typical 2,000-hour-a-year job.
That's barely above the $7.25 hourly minimum wage.
(Of course, Social Security benefits aren't taxed unless you have substantial other income, which means it's not a perfect apples-to-apples comparison. But it's pretty close: By the time typical minimum wage earners get their refundable tax credits back, their tax picture looks about the same as a Social Security recipient's.)
Can You Live on Less Than $1,000 a Month?
For those anticipating a retirement financed by Social Security, $15,000 a year is far from enough to lead even an "average" lifestyle.
Wait, it gets worse. That $1,229 a month is what you get before any Medicare premiums are deducted.
Once you deduct the typical premium costs for that subsidized health insurance program for seniors, there is substantially less left over. The table below shows typical premiums for Medicare recipients, above and beyond what they paid in taxes while working to support the program:
Typical Monthly Premium
Total Typical Premium
Sources: Medicare, HHS, Weiss Ratings, and q1medicare.com.
Subtract that $304 from the average $1,229 monthly Social Security check, and the average retired senior is left with about $925 per month to spend on -- well, everything that isn't health insurance. You know, food, clothing, shelter, transportation, and the other costs of living.
By this point, one thing should be abundantly clear: You're not likely to have much more than a bare-bones retirement if you're planning to live on Social Security alone. And that's even before the Social Security Trust Fund evaporates around 2036, slashing expected benefits by about a quarter.
Kicking the Legs Out from Under Your Finances
Back when traditional pensions were a common employee benefit, the retirement planning was visualized as a "three-legged stool." Social Security provided one of the legs, with your pension and personal savings making up the other two.
These days, Social Security's problems are well known and private pensions are available to far fewer employees than they once were -- which leaves your personal savings to pick up the slack.
That's not an impossible hurdle to clear if you've got a few decades before you retire. But if you plan to stop working in a time frame measured in years rather than decades, you've got a challenge ahead of you. You'll need quite the nest egg to cover the costs not covered by your Social Security check if you want your money to last at least as long as you do.
How Big a Nest Egg You Need
The most common guideline used to determine the amount of money someone needs in order to retire is based on a formula known as "the 4% rule."
That rule suggests that retirees can spend 4% of the value of their well-diversified portfolio in the first year of retirement, adjust the amount upward by inflation annually, and be reasonably assured that their money will last through a 30-year-long retirement.
Based on that rule, that means your portfolio needs to be 25 times the size of your annual spending not covered by your Social Security checks.
Say you're spending $48,109 a year -- the amount spent by the typical American household in 2010. To keep your current lifestyle in retirement, you'll need a portfolio of at least nearly $1 million, even with Social Security. The table below shows why:
Net Annual Spending
Annual Expenses Investments Need to Cover
Require Portfolio Size
Source: author calculations, based on values mentioned earlier
It's true that if your house is paid off, your children are grown, and you no longer have to cover the expenses of working, your cost of living may drop somewhat. But then, factor in increased out-of-pocket medical costs, and possibly the desire to travel while you're still young enough to enjoy. Those two items alone could eat all the savings you accrue from the other budget reductions, so you'll still be spending the money -- just in other ways.
So don't count too much on reduced expenses -- or Social Security. You're going to need a jumbo nest egg to enjoy retirement.
For more on managing your money for (and during) your golden years, see:
Motley Fool contributor Chuck Saletta appreciates your comments.
Correction: An earlier version of this article said that Social Security benefits were tax free under all circumstances. Social Security benefits may be taxed in some circumstances, See: http://www.ssa.gov/planners/taxes.htm.