A Small COLA For Seniors
The Social Security Administration recently announced that the cost of living adjustment (COLA) for 2017 benefits would be 0.3% due to the relatively low inflation rate. For the average Social Security recipient, that equates to an extra $5 per month. While the COLA is tiny, it's still an improvement on the zero COLA recipients “enjoyed” for 2016.
If COLAs are based on inflation, why would a low COLA cause difficulties for seniors? Three reasons: the time lag in COLAs and current inflation, the way inflation is calculated for Social Security purposes, and concurrent Medicare expenses. All three causes manifest themselves the same way: increased expenses are likely to outpace the meager increase in income.
Not All Inflation is the Same
By definition, COLAs are backward looking in nature. The amount you receive in the future is based on inflation data from the recent past. That offset in timing works to your advantage if inflation is decreasing, but when the rate of inflation is rising, your check will not go as far.
Inflation reflects rising prices — but to capture the effect on seniors, it is important to distinguish which prices are rising. Social Security COLAs are calculated based on the past three-month values of the Consumer Price Index for Urban Wage Earners and Clerical Workers, known as the CPI-W. This is derived from the CPI-U that is more reflective of the entire US population.
The CPI-W provides a higher weight to transportation costs and thus has been skewed downward by the relative collapse of gas prices compared to other prices. Because seniors spend less on gas compared to items with rising costs, especially medical care expenses, Social Security recipients are likely to receive COLAs that are less reflective of their actual expenses.
The experimental CPI-E is weighted toward expenses that are more typical of elderly consumers, and some are advocating its use in calculating Social Security COLAs — but to date, the CPI-W still prevails.
At least the law prevents across-the-board cutting of Social Security benefits when the CPI is negative. To arrive at a 0.3% increase, the CPI-W for 2016 was compared to the CPI-W for 2014 in the same time period (recall the zero increase in benefits for 2016, the result of a negative CPI-W when comparing 2014 to 2015).
Some seniors are going to have an even more difficult time making ends meet as their tiny COLA is likely to be gobbled up (and then some) by increased Medicare Part B costs. The 2017 premiums have not been announced yet, and they have been predicted by the Medicare Trustees to be relatively flat — but Social Security recipients will still likely pay more due to a provision called "hold harmless."
In general, Part B premiums are automatically deducted from Social Security benefits. The hold harmless provision keeps Part B premiums from rising more than the COLA in their Social Security benefits, essentially preventing a net decrease in Social Security benefits. Because of no COLA in 2016, the component of the premium increases that should have taken place in 2016 will be passed through in 2017 (to the extent allowable by hold harmless).
However, about 30% of recipients are not covered by hold harmless because they fall into one of the following categories: they have higher incomes and thus pay more than the 25% share of Part B costs that the average Social Security recipient pays, they are at a poverty level such that their premiums are paid by Medicaid, or it is the first year they have claimed Social Security (and thus have no reference point for a cut). This group ends up picking up the slack for those covered by hold harmless — unless Congress intervenes to hold those increases down, as they did in 2016.
The 2016 deal would have similarly held down costs for this 30% of Social Security recipients, but only if there were no COLA. Strangely, for the 30% outside of hold harmless, a small COLA could be worse than no COLA at all.
Congress and the White House could intervene again, but let's just say they are more distracted this year than usual.
Bad News for Some Non-Recipients
Meanwhile, if you are on the other side of the Social Security equation and paying into the system at the maximum rate because of your high earnings, prepare for some bad news. High-earners will be paying more because of a significant change in the Social Security wage base (the value beyond which wages are exempt from Social Security tax).
The trigger mechanism for change is an increase in average American wages, with a caveat — the wage base can't be increased in years when there is no Social Security COLA, such as 2016. Thus the wage base increase from $118,500 to $127,200 represents two years of growth in average earnings, resulting in up to an extra $539.40 deducted from an employee's' paycheck (and worse for the self-employed who must pay twice the amount to also cover the employer's portion of the Social Security tax).
The same two-year phenomenon works to the advantage of those who are working while drawing early Social Security benefits. The threshold monthly earnings at which a recipient's benefits are reduced have increased by more than 7% ($1,410 per month from ages 62-65 and $3,740 per month at age 66). Given the meager increase in COLAs over the past seven years, with three years of zero COLA (2010, 2011, and 2016), seniors drawing early benefits may need to use this provision and find ways to increase their semi-retirement income to make ends meet.
Current recipients of Medicare and Social Security are used to the annual cost-benefit balancing act, and have learned to deal with it as best they can. Those who were fortunate enough to establish a solid retirement plan are not as dependent on Social Security and are able to withstand these changes without major lifestyle ramifications.
For those who haven't reached retirement, the message is clear: provide as much for your own retirement as possible and consider your retirement age carefully. If you can afford to do so, delay drawing your Social Security benefits past your full retirement age (66 or 67 depending on your year of birth) and receive an extra 8% per year up to age 70. At the least, try to avoid reducing your benefits by claiming them early.
How do you bridge the gap? Build your retirement funds through investing early and taking as much advantage of compound interest and IRAs/401(k)s as possible. Would you rather have an extra morning latte every day of your working life and an extra meal out each week, or a stash of retirement funds that could allow you to avoid making the choice between food and your necessary prescriptions? That choice is up to you.
Let the free MoneyTips Retirement Planner help you calculate when you can retire without jeopardizing your lifestyle.