Protect Your Social Security Benefits From Inflation

When the Social Security Administration first issued benefits in 1940, there was no provision in place for economic inflation. Unfortunately, this meant early beneficiaries saw the buying power of their benefits erode as the years went by. This is why the Social Security Administration enacted the annual cost of living adjustment (COLA) provision as part of the 1972 Social Security Amendments, and automatic annual COLA updates began in 1975.

The Consumer Price Index Measures Inflation

The Social Security Administration uses an index known as the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-U) in its current formula to calculate the annual COLA for beneficiaries. The CPI-U tracks the overall inflation of goods and offers a reasonable benchmark for determining what increase in Social Security benefits will keep pace with inflation.

Elasticity of Demand not Accounted for 

Though the CPI-U does provide a general sense of market inflation, there are some downsides to using it for COLA calculation. First, the CPI-U does not take into account what economists call the elasticity of demand. This occurs when the price of one type of good goes up, so frugal shoppers decide to buy a different good. For instance, if the price of beef were to go up, many consumers would choose to buy other meats or meat substitutes instead.

This elasticity of demand is why some economists and experts suggest switching the COLA formula from CPI-U to a chain-weighted CPI. This kind of index reflects the fact that consumers make purchasing substitutions when prices rise, which means the chained CPI calculates the rate of inflation about 0.3 percentage points lower than the CPI-U.

But other critics worry that rather than providing too large a COLA, the CPI-U doesn't adjust benefits enough to offset the specific types of inflation that affect seniors most. Older consumers are more likely to use goods and services that may not have lower-priced substitutions, such as medicine and healthcare. (For related reading, see: Why the Consumer Price Index (CPI) Is Controversial.)

Social Security Recipients Will See Increase

The Social Security Administration has announced that the 2018 COLA increase will be 2%. While 2% is a relatively low increase, it is still the largest COLA increase since 2011. There was no COLA increase for 2016, and 2017 only saw a COLA of 0.3%.

Falling gas prices were partially responsible for the lack of a COLA increase in 2016. Unfortunately, since the majority of Social Security beneficiaries no longer need to commute, low fuel prices did not necessarily offset cost-of-living expenses that did experience inflation. For many seniors on fixed incomes, seeing no COLA increase in 2016 was a stressful exercise in pinching pennies.

Inflation-Proofing Your Benefits

2016 was not the only time in recent memory that current beneficiaries saw no increase. In the aftermath of the 2008 market downturn, there was no COLA increase for 2009 or 2010. While the lack of a COLA increase may have reflected the reality of slow inflation in our economy, it was still devastating for many beneficiaries.

There are several ways to make sure you are not overwhelmed by inflation, whether or not the Social Security Administration provides an ample COLA increase. Here are three ways to protect your benefits from inflation:

  1. Wait as long as you can to take your benefits. The longer you wait between age 62 and age 70, the higher your benefits will be. For each year you wait, your monthly benefit increases by approximately 8%, which can make a big difference in cushioning your retirement income from inflation.
  2. Adjust your spending based on COLA announcements. The Social Security Administration announces the following year’s COLA increase every fall, which means beneficiaries have time to prepare before low- or no-COLA-increase years. For instance, if you receive a $2,000 per month benefit, receiving a 2% increase is only $40 per month. If you know that no increase will be coming, you have some time to find $40 per month to trim to help make up the difference.
  3. Have Medicare Part B premiums deducted from your benefits. Having your Part B premiums deducted from your Social Security benefit can potentially help you to weather no-COLA-increase years. That’s because of something called a hold harmless law: If Medicare premiums rise, but the COLA does not, beneficiaries who have their Part B premiums deducted from their Social Security benefits will not see those premiums rise. The law specifies that Medicare Part B premiums cannot go higher than the previous year’s COLA increase.

In an ideal world, the Social Security Administration would find a COLA formula that covered all cost of living increases for all beneficiaries every year. Since that’s not possible, individual beneficiaries needs to plan ahead for the effects of inflation. In your ideal retirement, your COLA increases will be nice bonuses to your retirement income rather than something you count on to stay afloat.

(For more from this author, see: Social Security Claiming Options for Singles.)


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