Social Security Benefits Get Historic Rise

Retirees and other Social Security recipients will be happy to hear that their benefits will see a significant increase in January 2023.  The Social Security Administration has announced that benefits will receive a cost-of-living adjustment (COLA) of 8.7%. 

Since 1975, Social Security benefits have been adjusted to compensate for inflation.  Before then, increases were set by legislation.  This is the largest increase since 1981 and the fourth-largest increase ever.  The average increase in benefits since 1975 is 3.8%.  From 1975 to 1982, the annual adjustment was well above this long-term average while the period from 1983 to 2021 only had mild inflation adjustments most of the time.

This is welcome news for retirees who are paying more for gas, food, and other goods.  In addition, Medicare recipients will pay less for the base cost of Medicare Part B premiums in 2023.  The monthly cost is scheduled to drop from $170.10 to $164.90 per month for most seniors.  Many Social Security beneficiaries pay their Medicare Part B premiums from their gross Social Security benefits.  Those who do will see both of these changes positively affect their net take home direct deposits.

However, when it comes to taxing Social Security benefits, the tax code has not been updated to reflect inflation since the Regan Administration.  Individuals with an income of $34,000 and married joint filers with more than $44,000 can have up to 85% of their Social Security benefits taxed.  Taxpayers count half of their Social Security benefits along with their other income and even municipal bond interest to calculate how much of their Social Security benefits are included in their taxable income. 

For working Americans, the Social Security wage base will also be increasing from $147,000 in 2022 to $160,200 in 2023.  This is the amount of wages or self-employment income that is subject to Social Security taxes of 12.4% (6.2% for both employee and employer). 

The latest estimate from the Social Security Board of Trustees calls for the Social Security trust fund to run out of money in 2035.  At that time, they project that tax revenue from Social Security taxes would only cover 80% of the promised benefits.

Planning Moves to Make in a Down Market

We all know the headlines in 2022 haven’t been great.  Inflation is persistent, there is a war in Europe, and the broad stock market index is down 25% over the first three quarters of the year.  However, it is our privilege as free-thinking human beings to choose how to react to unwanted conditions.  Some of our worst experiences can be our best opportunities.  Here are some financial moves worth considering to take advantage of a depressed stock market.

1-       Focus on long-term goals instead of short-term volatility

Long-term, goal-focused, plan-driven investing can be a grind that takes decades to fully realize our goals.  It can be difficult; however, it is also much more likely to succeed than get-rich-quick schemes.  Being a successful investor requires keeping our eyes on the long-term prize even as the market can take years of progress away quickly.  Making matters worse is the fact that in the realm of long-term investing, the term “short-term” may mean a few years; holding on through the “short-term” declines when months and sometimes years roll by.  A good way to change our perspectives during a market decline is to update our long-term financial plans and projections with the latest figures.  They tend to show a lower probability of success than when our accounts were at market highs, but they also tend to be affected to a smaller degree than we might have guessed.

2-      Increase contributions and deploy cash

Warren Buffett, one of the greatest investors of all time, said to “be fearful when others are greedy, and greedy when others are fearful.”  This is a direct and opposite correlation between prices and future expected returns.  In other words, the moment with the greatest opportunity is when prices are low and pessimism is high.  Emotionally, it is difficult to invest new money as we have seen the markets draw down our life savings, but rational investors are treated to the returns they deserve over time.  Times like these are the best opportunity we have to keep contributing to our accounts, increase our contributions if we can, and deploy cash that can be used to support our long-term goals.

3-      Rebalance

Rebalancing is a process of regular investment portfolio maintenance. An intentional investment portfolio has a target allocation of stocks and bonds as well as minor allocations within stocks and bonds covering various corners of the market.  As asset values shift, portfolios naturally deviate from their intended targets and rebalancing is the process of bringing them back.  In practice, what this really means is selling some of the assets that have performed well and buying more of the assets that have not performed as well.  In a down market, this typically means selling bonds and buying stocks.  Rebalancing is a way of taking advantage of a down market by buying more when prices are depressed to take advantage of the recovery that inevitably comes.

4-      Trim concentrated stock positions

For a myriad of reasons, sometimes investors end up with a large position in a single company.  Often, this is a stock that was given to them by parents or by buying shares in a company the investor worked for.  If they have held the stock a long time, it may have appreciated to several times the original investment.  In this scenario, holding the stock can become risky if it represents too much of the overall portfolio and selling the stock comes with large capital gains taxes.  In a down market, the stock’s value may be closer to the cost basis, which would make a sale of some of the shares an easier tax hit.  This can be a great opportunity to reduce exposure to a single company with lower tax consequences.

5-      Tax loss harvesting

Along those same lines, bear markets tend to make for better tax years as most of the shares sold generate capital losses instead of gains.  If you have realized capital gains, selling some of the positions that are down relative to their purchase price will result in capital losses that can offset gains.  There are two caveats to think through before harvesting losses.  The first is that capital losses can only offset capital gains and up to $3,000 of ordinary income.  Anything beyond that will be carried forward to future tax returns.  Also, positions sold at a loss cannot be repurchased within 30 days of the sale for this strategy to work.  If they are repurchased, this is considered a wash sale in which the IRS declares that the original shares were not really sold at all.

6-      Roth conversions

Roth IRAs are wonderful investment instruments because they grow tax free, they don’t have minimum distribution requirements like Traditional IRAs, and they can be passed on to our heirs tax free.  The only trouble is getting assets into Roth IRAs in the first place.  Contributions are limited while we are working and moving assets from a Traditional IRA to a Roth IRA (known as a Roth conversion) means paying taxes on the amount converted.  While a down market doesn’t change any of this, it does mean that investors can convert more shares for the same dollar value in a Roth conversion.  It also means that there is a large probability of good markets ahead when valuations are down.  If that turns out to be true, that appreciation would occur in the tax-free Roth IRA instead of the tax-deferred Traditional IRA.

7-      Distributions from Non-Qualified Variable Annuities

This is a tricky recommendation because I haven’t found many good reasons to invest in most annuities.  However, if you already have made this investment, you may know that your lifetime contributions are considered basis and the lifetime gains are taxed as ordinary income.  If you take a partial distribution, the gain comes out first and then the basis second.  If a down market results in the annuity value coming close to your cost basis, you may consider withdrawing funds and getting them taxed with the goal of drawing down the annuity to its basis.  At that point, you could withdraw the basis without any taxes and save yourself the extra fees, insurance costs, and taxes that come with this investment.

8-      Triggering annuity Guaranteed Minimum Withdrawal Benefits

Some annuities come with Guaranteed Minimum Withdrawal Benefits or GMWB, which is an insurance product that guarantees that if your investment falls below your initial investment, you can make withdrawals each year until you receive all of your initial investment back or your total account value if the market has recovered.  In general, I think these products are unnecessary, expensive, and come with provisions that stipulate that you can’t withdraw all of your money for the first several years of the policy.  Meanwhile, the insurance companies that underwrite them know full well that the probability of a market that remains down for a long period of time (like 7-10 years) is quite unlikely.  Basically, they provide protection for short-term volatility while demanding that you lock up your money for the long-term.  In any case, if you happen to have one of these policies and its current value is less than your contributions, this may be a good time to trigger this benefit and beat the insurance company.

Putting Bears and Bulls in Perspective

Of all the charts I have seen this year, this chart below gives the most historical perspective.  It outlines all of the bull and bear markets since 1942.  The conclusions I have drawn are quite intuitive with a quick glance.  First, that bull markets are longer, larger, and permanent while bear markets are shorter, smaller and temporary.  Second, that the biggest concern we should have at a time like this is not a possible further decline in stock values but missing out on the next multiyear return to a bull market.