Low interest rates hurt savers on fixed incomes, particularly retirees. But low rates hurt retirees in another way. One of the reasons why interest rates are so low is because inflation is low. When inflation is low, annual Social Security cost of living increases (COLAs) are also low or non-existent.
That shouldn't be a problem if inflation was even for all items and COLAs matched the reality of what people purchase in different stages of their lives. That certainly has been the case for retirees with higher medical and prescription drug costs, which have increased 75% over the past 16 years. COLAs, meanwhile, have increased benefits by just 36%. According to a 2016 survey of senior costs conducted by the Senior Citizens League (TSCL), Social Security beneficiaries have lost 23% of their buying power since 2000, based on 38 key items in a typical retiree's budget. Put another way, for every $100 worth of expenses seniors could afford in 2000, they can afford just $77 today.
Automatic adjustments based on the Consumer Price Index (CPI) started in 1975. Prior to that, it literally took an act of Congress to give beneficiaries a COLA. The COLA is based on the CPI for Urban Wage Earners (CPI-W). An increase kicks in when inflation as measured by the CPI for Urban Wage Earners (CPI-W) increases over the prior 12 months from third quarter of the previous year. The COLA for 2017 — if any — would be based on the increase in the third-quarter average CPI-W for 2016 over the third quarter of 2014, the last year in which a COLA became effective.
Since 2010, there have been three years with no COLAs. We may as well add 2017 to the total, as the Social Security Administration announced a paltry 0.3% COLA for 2017.
Enter Medicare into the Equation
The good news is that, due to a hold harmless provision in the law, if there is no COLA for Social Security, there is no Medicare premium hike. However, not everyone escapes the Medicare premium increase.
If you are subject to Medicare premium tax—called the Income-Related Monthly Adjustment Amount (or IRMAA), you are not protected. You will pay an additional amount for your monthly Medicare Part D prescription drug plan premiums and your monthly Medicare Part B (out-patient or doctor visit coverage) premiums. The additional premium amounts of $187 and $13 for Part D kick in for individuals with a Modified Adjusted Gross Income (MAGI) of $85,000 and $170,000 for couples, and goes up from there. Some couples earning more than $428,000 in 2015 could be subject to IRMMA premiums of $428 plus $76 for Part D. That's on top of your insurance premiums!
Also, if you are newly entitled to Medicare in 2017 or if you are enrolled in Medicare but have not yet started to collect Social Security benefits, such as if you continue to work beyond age 65 or you elected to file and suspend your Social Security benefits before the April 29, 2016, deadline, you will also pay the higher Medicare premiums.
If small COLA adjustments are going to be the norm, perhaps they should be modeled into your planning and investing. Have your advisor model different Social Security, health care expense, inflation rates, and investment assumptions into your retirement projections. You may need to give yourself a raise each year from a well-designed investment portfolio, taking on a little more risk in exchange.
The IRMAA issue might require a sharpened pencil or advanced Social Security planning spreadsheets. Quite often it is a temporary situation, unlike a lifetime of inflation-adjusted Social Security benefits. If you are planning a Roth IRA conversion or if you think you may be in a higher income situation for an extended number of years, seek advice to help you weigh the short-term costs against the longer term benefits of delaying Social Security benefits.