The federal government has reported that there will be no cost of living adjustment (COLA) on Social Security benefits for 2016. This is the third time this has happened since the automatic increases were adopted in 1975; it also happened in 2010 and 2011.
Social Security Benefits and the Cost of Living Adjustment
Social Security is a social insurance program that provides benefits to elderly, blind, and disabled people and certain dependents. The program is funded via Social Security taxes paid by employers, employees, and the self-employed. The various benefits administered by Social Security are designed to meet different kinds of needs, from pensions for retired workers to cash assistance for low-income people with disabilities. There are about 50 million retired and disabled Americans who receive Social Security benefits.
The amount of benefits a Social Security recipient collects each month is determined by the person's earnings history. The average monthly benefit for retirees is around $1,340 and $1,170 for those with disabilities who receive SSDI. Once an individual starts receiving monthly benefits, whether due to retirement or disability, his or her monthly benefit is typically increased each year to keep pace with the general increase in prices—this is known as the Cost of Living Adjustment (COLA). Indexing the Social Security benefit to inflation prevents the purchasing power of beneficiaries' monthly checks from decreasing over time.
Inflation typically occurs due to an increase in the money supply and often results in rising prices from one year to the next. In practical terms, this means that 100 dollars was worth more in 1980 (or even a few years ago) than it is today. The same is true for your Social Security benefit: the amount you received last year is worth less even though it's the same in nominal terms. To maintain the same purchasing power, Social Security benefits are usually increased yearly by a COLA.
The COLA is determined each year by the Social Security Administration based on inflation over the previous year. In particular, SSA looks at uses a measure called the CPI-W, the Consumer Price Index for Urban Wage Earners and Clerical Workers, which looks at price changes of a "basket" of goods and services to determine the rate of inflation. The CPI-W is calculated by the Bureau of Labor Statistics, and measures the prices of food, clothing, housing, transportation, medical care, recreation, education, and many other goods and services.
For example, the COLA applicable to Social Security benefits payable in January 2009 was 5.8%, calculated on the basis of inflation observed between 2007 and 2008. However, for 2016, as in 2010 and 2011, the COLA is zero, largely because low energy prices have meant flat or even negative measured rates of inflation. By law, however, the government can't reduce Social Security benefits from one year to the next, so even negative rates of inflation will not result in a Social Security benefit decrease.
Some observers and many Social Security recipients think that the lack of a COLA in 2016 was a mistake. One argument is that the CPI-W is not an accurate measure of inflation's impact on seniors, and that the Consumer Price Index - Elderly (CPI-E) should have been employed instead. The CPI-E is a measure that gives greater weight to goods and services used disproportionately by seniors—medical care, for example.
Others argue that Social Security recipients shouldn't get an cost-of-living increase when inflation is flat or negative. Because the COLA is designed to maintain purchasing power, they maintain, it does not make sense to offer a COLA when they're is no inflation. Moreover, even if the CPI-E measure were used instead of the CPI-W, that would only result in a 2016 increase of .2%. Finally, many argue that the Social Security program is not sustainable in its current form, and that savings must be found wherever possible.
The Medicare Safe Harbor Provision
For millions of individuals whose Medicare Part B premiums are deducted straight from their Social Security check, a federal "safe harbor" provision effectively freezes their Medicare premiums when the COLA is zero. This law is intended to prevent Social Security benefits from decreasing in nominal terms from one year to the next.
When this happens, those who enroll in Medicare Part B for the first time during a zero-COLA year, along with those who are not collecting Social Security benefits, will pay higher Part B premiums than those whose premiums were frozen under the safe harbor provisions.
Questions for Your Attorney
Depending on your situation, it may be a good idea to contact an estate planning or tax adviser about these developments. Some common questions for your attorney might include:
- How will the absence of COLA or changes in Medicare premiums affect my financial situation?
- How much can I expect to receive in Social Security benefits when I retire? Is it wise for younger workers to factor Social Security benefits into their planning at all?
- Do I need to make any changes now to my retirement plans in light of possible changes to Social Security that may occur?