COLA increase still won’t cover Medicare, income tax for retirees, report says

The Social Security Administration is expected to announce the largest cost of living adjustment in four decades — 6% — soon, because of the rise in inflation. But a report by the Center for Retirement Research at Boston College found that a jump in inflation could also mean the COLA may not keep up with the rise in Medicare premiums and more taxation under the personal income tax.

“We don't know exactly what it will be because we haven't gotten there yet, but we know that if inflation continues to rise at a rate similar to what it has been in the last couple months or even just stays constant from now through the end of the third quarter, we're looking at somewhere between a 5% and 6% cost of living adjustment for Social Security benefits,” said researcher Patrick Hubbard in an interview with Financial Planning.

AARP seniors retirement
(Bloomberg News)

“A lot of people might respond to this news with ‘that’s great, it’s good news for retirees’ because it gives them more money and it allows them to keep pace with inflation, which is a goal, and it's a very necessary thing to have. But we wanted to also point out that there are a couple of other things in addition to the COLA that can undermine the ability of the COLA to offer full inflation protection,” Hubbard said.

Every year, Social Security benefits get a cost of living adjustment to protect beneficiaries against the effects of inflation. The Social Security COLA is based on a consumer price index for urban wage earners and clerical workers (CPI-W) from the Bureau of Labor Statistics.

Inflation “limits the ability of beneficiaries to fully maintain their purchasing power” and undermines the inflation protection offered by Social Security, researchers Alicia Munnell and Hubbard said in the report.

“Rising Medicare premiums mean that a larger and larger chunk of the Social Security benefit goes to health insurance, so the net benefit available for non-health expenditures does not keep pace with inflation,” according to the report.

Medicare premiums are income-related and automatically deducted from retirees’ benefits. For single individuals with incomes of $88,000 or less and married couples with $176,000 or less, the monthly premium in 2021 is $148.50. The premium rises for taxpayers above these thresholds, reaching a maximum of $504.90 per month for those at the highest incomes, according to the report.

“As medical costs go up with inflation and as medical expenditures go up in general for other reasons, so, too, will the Medicare premium,” Hubbard said. “They are matching inflation, but there is the possibility that the increase in benefits retirees get won't actually be, in real terms, as high as they could be.”

Between 2000 and 2020, the average annual adjustment for the Part B premium has been 5.9% compared to the average annual Social Security COLA of 2.2%.

“For some lower-income people, Medicare premiums can take their entire COLA if they have a very low benefit. This could be true for a higher-income couple if one spouse is taking a spousal benefit just temporarily… They are going to be subject to those surcharges and pay a higher portion of Part B premium than other beneficiaries,” said Mary Johnson, Social Security and Medicare policy analyst of The Senior Citizens League.

The report also found that personal income tax with unindexed thresholds for benefit taxation “means that wage growth and inflation will subject an increasing portion of Social Security benefits to taxation.”

The report also said rising benefit levels also subject more benefits to taxation because taxes are levied on Social Security benefits only for households with income above a threshold of $25,000 for single taxpayers and $32,000 for joint returns. These thresholds are not adjusted for wage growth or inflation, reducing the net benefit. Above those thresholds, recipients must pay taxes on up to 85% of their benefits, according to the report.

“Because the thresholds are not increased in response to either wage or price growth, more and more beneficiaries are being taxed on their Social Security benefits over time,” the report said. “When the taxation of benefits was first introduced in 1983, only 8% of eligible families paid taxes on their benefits. Today, the estimate is that 56% of beneficiary families pay taxes on their benefits. Under moderate inflation, that percentage is projected to increase to 58% in 2030.

“Even Social Security does not fully insulate older households from inflation’s erosive impact,” the researchers wrote in the report.

Johnson said there are issues with the COLA, specifically how it is calculated using the CPI for urban wage earners and clerical workers because it focuses on the buying patterns of younger, working adults and does not survey the buying patterns of retired households.

“It’s one of the ironies of the COLA. In the past 12 years, the cost of younger working adults has tended to be much lower than the costs of older adults. For example, under the CPI-W, gasoline is given a bigger portion of the spending of younger working adults. Retirees, though, who aren't commuting to work or traveling quite as much, they're spending more of their money on housing and medicine. So there's two different spending patterns.”

Over the past 12 years, she said, COLAs have averaged 1.4%. In 2021, it was 1.3%. Soaring gas and energy prices are causing “hyperinflation” driving Johnson’s estimate up to 6.2%.

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