Remember the old Dr Pepper commercials promoting the fact that this famous soft drink, which was created in the 1880s and was first nationally marketed in the United States in 1904, was “so misunderstood.” I’m a firm believer that this saying also applies to a non-soft drink COLA brought to you by the Social Security Administration.
Every year since 1975, the Social Security Administration calculates a cost-of-living adjustment, or COLA. The 1975 – 1982 COLAs were effective with benefits payable for June in each of those years. Since 1982, COLAs have been effective with benefits payable for December.
The COLA has always been based on an annual increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Since 1983, COLAs have been calculated using increases in the CPI-W from the third quarter of the prior year to the corresponding quarter of the current year in which the COLA became effective. The 2012 COLA of 1.7% was announced in October and will apply to benefits payable beginning in December.
Per the Social Security Cost-of-Living Adjustments table below, there were sizeable annual increases the first eight years from 1975 to 1982. The increases ranged from a low of 5.9% in 1977 to a high of 14.3% in 1980, averaging 8.7% during this period. The COLA decreased to 3.5% in 1983 and further declined to 1.3% in 1986 before climbing to over 4% for four straight years beginning in 1987. There have been only two years since 1982 when the COLA exceeded 5% (1990 – 5.4% and 2008 – 5.8%). There were also two consecutive years recently in 2009 and 2010 that saw no increases.
Since its roaring start the first eight years, average COLA increases have declined dramatically and have remained consistent over extended periods of time. They have averaged 2.6%, 2.5%, and 2.9% for the last 10-, 20-, and 30-year periods, respectively. As a result of their initial jump start, COLA’s have averaged 4.1% over their 38 years of existence.
Although average annual increases have remained below 3% for extended periods of time over the last 30 years, Social Security recipients have kept up with inflation as measured by the CPI-W. Someone still alive today who started receiving benefits in 1975 has seen a 354% increase in benefits, with 108% of the increase attributable to COLA’s during the first 10 years. For the individual who began receiving benefits in 1982, her benefits have increased by 134% over the last 30 years. Benefits have doubled over the last 25 years as a result of COLA’s.
With only two COLA’s exceeding 4% in the last 20 years (4.1% in 2005 and 5.8% in 2008), the pace of the total increase in Social Security benefits has declined significantly. If you began receiving benefits 20 years ago in 1992, you have seen an increase of 63%. If your start year was 2002, your benefits have increased by 29%. Finally, the total increase over the last five years has been only 11%.
Despite the fact that Social Security recipients have enjoyed sizeable cumulative increases in their benefits over the past 20+ years, another reason why COLAs are often misunderstood is due to their accounting treatment. Social Security benefits are reduced by the Medicare Part B premium that helps pay for doctors’ services and outpatient care. The monthly premium for most individuals in 2012 is $99.90. Although Medicare premium increases cannot be greater than the COLA, Social Security benefit increases are diluted to the extent of any increase in Medicare premium.
Enjoy your COLA’s!
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.