Cost of Living Adjustment for Social Security

• The Cost of Living Adjustment is based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W)
• There are alternative ways to base the Cost of Living Adjustment, such as against the CPI-E or the Chained CPI

Social Security is essential to retirement planning because it includes increases that account for the rising cost of living. This is especially important, considering retirees can go on living 25 years or more after they’ve left the workplace.

How Does the Cost of Living Adjustment Protect Social Security from Inflation?

Social Security bases its Cost of Living Adjustment (COLA) increases on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).

If there is a percentage increase in the average CPI-W between the current and previous year, then Social Security will increase retirement benefits by that amount. If there is no increase in the average CPI-W, then there is no COLA increase.

Cost of living increases have varied between 0.0% and 5.8% over the last 30 years, averaging 2.65% over that period. But in this decade, there has been no COLA increase in three different years.

At the time of this article, the fact that there was no COLA increase for 2016 and a very small one for 2017 has stirred up some discussion on how these increases are calculated and whether the CPI-W adequately reflects the spending patterns of older individuals — particularly with respect to medical spending.

So what are the possible alternatives for adjusting Social Security to reflect this increase?

The Experimental Price Index for the Elderly (CPI-E)

In 1987, the Bureau of Labor Statistics created the CPI-E, a price index that follows the spending patterns of individuals aged 62 and older. An analysis by Boston College’s Center for Retirement Research (CRR) revealed that the average annual increase for the CPI-E was 2.9% from the third quarter of 1983 to the third quarter of 2015.

Meanwhile, the CPI-W experienced an average annual increase of 2.7%. The difference between the two indexes in that 32-year period has been attributed to the higher cost of medical care for the elderly, according to the CRR. Some have argued that perhaps the CPI-E is a more accurate reflection of older Americans’ spending habits, compared to the CPI-W.

The Chained CPI

When drafting the 2014 budget proposal, President Obama had proposed that Social Security use the Chained Consumer Price Index instead of traditional CPI. The chained CPI assumes that when prices go up for a certain item, consumers will substitute that purchase with a similar but cheaper item. As a result, the chained CPI rises at a lower and slower rate than the CPI-W. If Social Security COLA increases were pegged to the chained CPI, benefit increases would be smaller. The Congressional Budget Office had estimated that a shift to the chained CPI could lower deficits by as much as $233 billion over ten years.

While these are only possible alternatives, cost increases are linked to CPI-W for the time being.

The Three-Legged Stool

The old retirement adage says that we should use the three-legged stool approach to prepare for retirement:

1. Social Security – This is the government’s retirement plan for us. As long as you’re working (to earn the credits required addressed above) and paying taxes, you’re earning Social Security credits. When you retire, you’ll start receiving monthly Social Security income that will continue for as long as you’re alive.
2. Pensions – This is the form employer retirement plans used to take. They provided a steady monthly paycheck no matter what happened in the market and no matter how long you lived. Because Social Security only covers, on average, 40% of one’s retirement expenses, people leaned on pensions for the rest. The problem today is that the second leg of the three-legged stool is wobbly or gone. Instead of offering pensions, employers are providing 401(k)s and matching contributions, which helps with the third stool.
3. Personal Savings – So that you have access to money outside of, and beyond, monthly Social Security and pension checks, you need to save on your own. This money is generally invested differently to serve two purposes. First, money invested in liquid money market or savings accounts provides a cushion and access to extra cash in case of emergency. Second, money beyond that can be invested in the market for a high potential return. This is the money you’re comfortable losing.

How to Supplement Your Social Security

According to the Social Security Administration, individuals aged 65 and over in the top quartile for income (an average of $78,180) received only 18% of their income from Social Security. So where does the remaining 82% come from?

Purchasing an Income Annuity

Income annuities provide a guaranteed lifetime stream of income during your retirement. You pay a lump sum upfront to purchase your annuity from an insurance company. Then, the insurance company sends you a series of payments for the rest of your life.

How Can I Purchase an Income Annuity?

At Blueprint Income, we offer annuities from more than 15 top rated insurance companies. Click below to get real-time personalized quotes.

Income Annuity Quotes

 

From there, you’ll get access to our annuity guides and team of specialists to help you analyze your retirement finances and walk you through the application process.