Cost-of-living adjustments (COLAs) are meant to raise your payments every year. People who get Social Security probably know how they work and how they raise your benefit. The percentage is the same for everyone, so it is added to the principal. The amount of the increase relies on both the size of the COLA and your specific benefits. But there are some other details about COLAs that not many people know. Remember these three important things.
COLAs are not guaranteed
It might look like people who get Social Security payments get more each year, but that doesn’t always happen. The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is used by the Social Security Administration (SSA) to figure out COLAs. The SSA finds the next year’s COLA by comparing the CPI-W from the third quarter of this year to the same quarter last year. This index shows how much different goods and services cost.
It is important to note that if the CPI-W does not rise, there is no COLA. Since COLAs were first put in place in 1975, this has only happened three times: in 2009, 2010, and 2015. It’s safe to say that you can expect a COLA most of the time, but sometimes it doesn’t happen, especially when inflation is low. Even though it sounds bad, a low or no COLA usually just means an economy that is stable as long as seniors aren’t losing buying power.
COLAs often fail to keep up with inflation
It’s supposed that COLAs will keep Social Security benefits worth the same amount even though prices are going up, but this doesn’t always happen. The Senior Citizens League, an independent group that speaks up for seniors, says that since 2000, Social Security benefits have lost about 40% of their buying power.
Because of this drop, seniors have to either cut back on spending or find other ways to make money to cover the costs that their Social Security checks used to cover. This is true even though the checks were never meant to replace 1% of their earned income.
Some experts say that using the Consumer Price Index for the Elderly (CPI-E) instead of the Consumer Price Index for the Working Poor (CPI-W) to figure out COLA could better match raises with how much seniors actually spend, since the CPI-E is more focused on goods and services that people over 62 usually buy.
The Senior Citizens League says that a senior who started getting average Social Security payments 30 years ago would have an extra $14,000 today if COLAs were based on the CPI-E instead of the CPI-W. This would be very helpful for seniors’ finances right now.
Even though this possible improvement is generally agreed upon, the problem has not been fixed. There are still political arguments going on, with some people wanting higher payments and others worried about how this will affect the money that Social Security has. For now, beneficiaries can only keep an eye on possible changes to the law and vote for leaders who support changes that might better meet their financial needs.
COLAs Can Increase Your Tax Burden
Even though COLAs usually mean more money, they can also mean that some people have to pay more in taxes. The federal government taxes people whose provisional income is more than $25,000, or $32,000 for married couples. Provisional income includes adjusted gross income (AGI), interest that is not taxed, and half of a person’s annual Social Security payout. Some states also tax the money you get from Social Security.
These tax levels haven’t changed in years, and they haven’t kept up with inflation or the rising cost of living, which makes things harder for people on fixed incomes. As benefit amounts go up, more seniors will make too much money and have to pay more in taxes, which can make their Social Security checks even less valuable.
People who aren’t ready for tax season may be in for a nasty surprise, and people can’t change the rules. But knowing how Social Security benefits affect your taxes and making plans for that can help lessen any bad financial effects.