A cost-of-living adjustment (COLA) is an enhancement to Social Security and Supplemental Security Income (SSI) to compensate for inflationary impacts. The percentage growth in the consumer price index for urbanized wage laborers and clerical employees (CPI-W) for a certain period is usually used to calculate cost-of-living adjustments. In 2022, the COLA will be 5.9%. So, if someone earned $10,000 in Social Security payments in 2021, they would get $10,590 in 2022.
Understanding Cost-of-Living Adjustment (COLA)
Because inflation was significant in the 1970s, COLAs were used to safeguard compensation-related contracts, real estate contracts, and government benefits. The CPI-W is determined by the Bureau of Labor Statistics (BLS), and it is used by the Social Security Administration (SSA) to calculate COLAs.
The COLA formula is calculated by multiplying the percentage rise in the CPI-W from one year’s third quarter to the following year’s third quarter. This information is updated on the SSA website regularly.
Before 1975, Congress enacted special legislation to boost Social Security payouts. In 1975, Congress adopted a COLA provision that provided automatic yearly COLAs based on the annual increase in the CPI-W. COLAs in 1975 were calculated using the increase in the CPI-W from the second to the first quarter of 1974. They were based on increases in the CPI-W from the previous year’s first quarter to the current year’s first quarter from 1976 to 1983. Since 1983, COLAs have been based on the CPI-W of the prior year’s third quarter to the current year’s third quarter.
Inflation rates throughout the 1970s ranged from 5.7% to 11.3%. In 1975, the COLA was increased by 8%, while inflation was at 9.1%. In 1980, the COLA hit its highest point in history, at 14.3%, against a 13.5% inflation rate. Small COLA increases of 2% to 3% per year were expected during the 1990s, thanks to dramatically lower inflation rates. Even lower inflation rates in the early 2000s resulted in no COLA adjustments in 2010, 2011, and 2016.
Special Considerations
The CPI-W and the employer-contracted COLA percentage are both used to calculate COLA. The CPI estimates the rate of inflation and compares it year after year. Recipients do not receive a COLA if consumer prices fall or inflation does not justify a COLA adjustment. There will be no COLA increment if the CPI-W does not rise. When a COLA rise is not authorized, Medicare Part B rates for about 70% of beneficiaries who have their premiums deducted from their Social Security payments stay unchanged. However, the remaining recipients must pay the Medicare Part B premium increases, including those with higher earnings, those who did not take part in Social Security via their employment, and new beneficiaries.
For 2021, the usual monthly Medicare Part B premium is $148.50, a $3.90 rise from last year’s figure of $144.60.
Alternatives to COLA
Some have questioned the methodology used to determine the cost-of-living adjustment. The SSA sets its COLA hikes on the CPI-W, as previously stated, using the spending habits of urban wage workers and clerks to create this index. The index comprises people who are employed and earning money, not retired people.
It’s natural to assume that spending patterns differ between those working and those who are retired, particularly with healthcare expenses. So why is it that a rise in Social Security benefits is based on an index that tracks a group that does not get benefits?
One alternative suggested is to base the COLA on an index that mainly tracks living costs for the elderly, such as the CPI-E. The CPI-E measures the spending habits of Americans aged 62 and up. While there has been a desire to replace the CPI-W with the CPI-E, this has not yet been implemented.
How Social Security could get affected from the biggest cost-of-living increase
The cost-of-living adjustment in 2022 will result in larger payouts for Social Security recipients. According to the Social Security Administration, the 5.9% rise, which will help beneficiaries sustain rising prices due to inflation, is the greatest in over 40 years.
Over 70 million Americans will receive larger checks as a result of the change. The change will take effect on Dec. 30 for the approximately 8 million Americans who get Supplemental Security Income, or SSI, and in January for the nearly 64 million who receive Social Security.
According to some projections, the 2022 cost-of-living adjustment will increase $92 per month to an average retirement pension of $1,565 per month. One of the most valuable characteristics of Social Security is the cost-of-living adjustment, said Nancy Altman, head of Social Security Works, an advocacy group focused on extending benefits.
Here’s all you need to explore about the COLA this year:
1. The good/bad things
A cost-of-living adjustment (COLA) will be given to Social Security recipients every year:
- Starting in 2022, payouts will increase by 5.9%.
- This is the greatest gain in this category since 1982.
- Payments will increase by $92 each month as a result.
- The expected monthly average for a Social Security beneficiary will rise to around $1,657. Benefits for a typical couple would increase by $154 per month, reaching $2,753.
For nearly 1 in every 5 Americans, the COLA has an impact on their household budget. Social Security recipients, handicapped veterans, and government retirees all fall within this category. According to the Social Security Administration, this comes to roughly 70 million people. This is the largest gain in this category for Baby Boomers since they started retiring roughly 15 years ago.
With so many items rising in cost, from the store to shipping, that substantial rise may not have much of an impact.
2. Don’t expect another big adjustment soon
Even though this year’s adjustment is a record, it really doesn’t mean that individuals on Social Security can expect comparable hikes shortly.
In fact, the large leap in 2022 could indicate that there won’t be any significant changes in the next few years. The last time there was a significant rise, it was 5.8% in 2009, and no modifications were made for the next two years.
3. The adjustment will be tarnished by inflation and Medicare
To be sure, recipients of Social Security benefits should realize that the COLA isn’t intended to allow them to spend more or have a larger budget; rather, it’s intended to keep their cost of living constant as prices increase due to inflation.
Inflation has pushed up the cost of rent, gas, utility, and food right now. Those on Medicare or Medicaid are unlikely to enjoy the whole 5.9% increase due to healthcare premiums.
Medicare Part B premium increases, for example, are set to take effect in November. According to the most recent Medicare trustees’ report, Part B will see a $10 hike in 2022, boosting the monthly fee to $158.50 from $148.50. Those contributions are usually deducted from Social Security and could reduce the adjustment.
However, because of Medicaid and Medicare, a unique rule known as the keep harmless clause shields people from receiving reduced Social Security payouts.
In December, beneficiaries should receive a letter from the Social Security Administration detailing their payments for 2022 when the premiums are notified.
4. Things you need to do
People who already receive Social Security benefits will have their checks automatically modified to reflect the increase. However, before it happens, beneficiaries should review their financial budget to see if they can put the extra money to good use.
Diahann Lassus, managing principal of Peapack Private Wealth Management in New Providence, New Jersey, said people need to look at the figures, what that hike means to them, and what it would mean for their monthly check. She believes a good amount like that may help some people consolidate debt or build an emergency savings fund.
“It’s kind of like when you’re working and getting a salary increase — are there other things you can do for you?” Lassus wondered.
5. Taxes may rise
According to Trenda Hackett, CPA and technical tax editor of Thomson Reuters’ tax and accounting department, taxes are unlikely to change if Social Security checks are your primary source of payment.
However, based on your other income, a portion of your checks may become taxable if you use your retirement funds in addition to Social Security or are working and getting benefits.
Suppose the income is likely to be over the base amount. In that case, taxpayers who get additional forms of revenue over the threshold amounts in addition to Social Security payments can expect an increase in the tax bill.
To avoid any unpleasant twists at tax time, consult with a tax adviser early to ensure you understand how the change will affect your taxable income.
