Wednesday, December 22, 2021

The Impact of Indexing: 13 Real World Examples

As we close out 2021 and get ready to welcome 2022, it is a good time to consider the impact of indexes (a.k.a., indices) on our financial lives. Many take effect upon the start of a new year. 


Some indexes adjust annual limits related to financial planning for inflation, some adjust interest earned or paid by consumers, and others measure the performance of something relative to a benchmark indicator.

 

So what, exactly, is an index? It is a number, either a flat dollar amount or a percentage, that is used to indicate a change in something (e.g., stock market performance) over time. 



Indexes typically reflect changes from a previous year or some other benchmark number. For example, the Consumer Price Index (CPI) measures changes paid by consumers for frequently-purchased retail goods and services.

 

There are many indexes that affect the financial lives of Americans on a regular basis. Below is a description of 13 common situations:


1.     Social Security Inflation Adjustments- Each year, the Social Security Administration announces inflation-adjusted percentages and numbers. In 2022, beneficiaries will receive a 5.9% cost of living adjustment (COLA). In addition, maximum taxable earnings will increase to $147,000, a quarter of coverage to $1,510, and the earnings limit under full retirement age to $19,560.

 

2.     Pension COLAs- Pension benefits for some retirees are also indexed for inflation. An example is pensions for federal government workers and military retirees and disabled veterans. Their COLA, like Social Security, is 5.9% (i.e., a $59 increase for every $1,000 of benefits) in 2022. Other pensions have frozen or suspended COLAs for their retirees (e.g., the New Jersey state pension plan).

 

3.     Income Tax Changes- Each year, income ranges for federal marginal tax brackets are indexed for inflation. The IRS publishes tables with the income ranges for four filing status categories and seven tax rates that currently range from 10% to 37%. Other tax numbers that get indexed are the standard deduction, certain tax credits, and the deduction for business-related and medical mileage.

 

4.     IRMAA Amounts- Income related monthly adjustment amounts (IRMAA) are extra charges that higher-income households pay for Medicare Part B and Part D premiums. The amount of income that triggers IRMAA is indexed annually for inflation. In 2022, IRMAA will be charged with a modified adjusted gross income above $91,000 (single) and $182,000 (married filing jointly).

 

5.     Estate and Gift Tax Exemption- The exemption amount in 2022 will be $12.06 million ($12,060,000), up from $11.7 million in 2021, for gifts and deaths that occur in 2022. In addition, the annual exclusion for gifts will increase to $16,000, up from $15,000.

 

6.     IRA Contribution Limits- The contribution limit changes occasionally based on an inflation-adjusted index formula. In 2022, however, limits remain the same as 2021: $6,000 for savers under age 50 and $7,000 (with a $1,000 catch-up) for those age 50+.

 

7.     Tax-Deferred Retirement Plan Limits- Like IRAs, maximum plan contributions are indexed for inflation. In 2022, retirement savers in 401(k)/403(b)/457 plans and the federal Thrift Savings Plan (TSP) who are under age 50 can contribute up to $20,500, a $1,000 increase from $19,500 in 2021. Older workers age 50+ can contribute up to $27,000 with a $6,500 catch-up contribution.

 

8.     Stock Market Performance- Every market trading day, indexes are used to measure the performance of different types of securities such as stocks. Examples include the Standard & Poor’s 500, Wilshire 5000, and Dow Jones Industrial Average (DJIA). The DJIA index closed on 12/31/20 at 30,409.56. During 2021, it rose through 31,000, 32,000, 33,000, 34,000, 35,000, and 36,000.

 

9.     Index Funds- Index funds are mutual funds that track a stock or bond index. They buy all the securities in an index, or a representative sample of it and provide about the same performance as the index they are tracking, fund expenses. Index funds have been in existence since 1976 when the fund known today as the Vanguard 500 Index Fund was launched. They maintain a significant cost advantage with many expense ratios less than two-tenths of one percent, compared to about 1.5% for average actively managed stock funds. Index funds also have low turnover (how often a fund buys and sells securities), which reduces transaction costs.

 

10. Pay Increases- It was widely reported that pay increased for many U.S. workers in 2021 as companies struggled to attract and retain workers. Many employers use a percentage of workers’ pay as a base to set raises or an index like the CPI. When pay for new hires increases, there is pressure to boost pay for experienced workers. During “The Great Resignation,” many workers quit jobs for better pay elsewhere.

 

11. Series I Bonds- With higher inflation in 2021, inflation-indexed I bonds received increased attention from investors. Twice a year- on the anniversary and semi-annual anniversary of a bond’s issue date- an investor’s I Bond is adjusted for inflation based on current inflation rates. From May 1 to October 31, 2021, I bonds earned 3.54%. From November 1 through April 30, 2022, the rate of return is 7.12%. Up to $10,000 of Series I bonds can be purchased electronically and bonds must be held at least 12 months. Another popular inflation-indexed federal government security in 2021 was Treasury Inflation-Indexed Securities (TIPS).

 

12. Variable-Interest Loans and Credit Cards- Compared with fixed-rate loans that have an interest rate (APR) that does not change, the interest rate on variable rate credit fluctuates according to changes in an underlying index such as the prime rate. The APR is often the designated index rate plus x%. Details about how APRs are set can be found in loan/credit card disclosure documents.

 

13. P-Fin Index- The TIAA Institute-GFLEC Personal Finance (P-Fin) Index, begun is 2017, measures multiple dimensions of U.S. household financial well-being and result changes over time. A comprehensive report based on survey data is issued annually.

 

In summary, indexes enable comparisons between, and adjustments to, various key numbers. What indexes will affect you in 2022?


This post provides general personal finance information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.


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