By Gail Buckner, CFP, Vice President, National Financial Planning Spokesperson, Franklin Templeton Investments
Retirees were likely quite excited to see news that their Social Security benefits are set to rise in 2018. Gail Buckner, CFP, our personal retirement and financial planning strategist, says of course that's a welcome development. However, she points out the 2% increase still leaves many Americans far short of what they are likely to need to meet expenses. She breaks down the details of the Social Security Administration's announcement for us-and outlines a new Congressional bill that may change the benefits equation down the road.
There's good and bad news about the announced increase in Social Security benefits starting next year.
Retired? Good News (Sort of)
If you are getting a monthly Social Security check, the amount you receive will go up 2% starting in January. Those who also qualify for a Supplemental Social Income (SSI) benefit will see it increased by the same percentage.
Although any increase is welcome news for the more than 66 million retirees-who did not see any increase in their 2016 benefits and got a boost of just three-tenths of a percent in this year's benefit amount-it's probably not worth getting too excited about.
Many older Americans are quick to point out that health-related costs are consuming a larger portion of their budget each year and even with a 2% increase in their monthly Social Security check in 2018, they are steadily losing ground.
A major study by the federal Centers on Medicare and Medicaid (CMS) confirms that the amount both the government and individuals spend on medical-related expenses has been going up for the past 50 years. In fact, health care expenditures have steadily increased as a share of gross domestic product (GDP), rising from 5% of GDP in 1960 to 17.4% in 2013.1
Moreover, this trend is expected to continue for the foreseeable future. Overall, Americans are expected to shell out 5.6% more on health expenses each year through 2024.2
You don't have to be retired to know that the prices you are paying for most things are higher today compared with a few years ago.
So why didn't retirees get a benefit increase last year? It's because of the way Congress requires Social Security to calculate inflation when determining whether benefits should be adjusted.
A Bit of History
Although we tend to expect Social Security benefits to automatically keep up with inflation, this is not how the program operated for its first two decades. Someone retiring in 1942-the first year that regular monthly payments began-could expect to receive the same benefit for as long as they lived. That's because changing Social Security benefits required an act of Congress-literally.
It took until 1950 for Congress to approve the first adjustment to Social Security benefits, an across-the-board increase of 77%.3 Future increases were far from annual and also required Congress to pass legislation. Although the United States did not experience double-digit inflation in the 24 years from 1950 through 1973 (in fact, it averaged around 2.5%), this did not stop Congress from passing some generous double-digit increases to Social Security beneficiaries over this timeframe, as you can see in the graphic below.
In the summer of 1972, Congress approved a 20% boost in Social Security benefits and then took itself out of the equation by passing legislation that fall which specified that, starting the following year, future increases would be tied to inflation. Specifically, the Consumer Price Index for Urban Workers (CPI-W) was the benchmark. It covers a wide range of expenses, from transportation to health care to food, clothing, housing and utilities.
Since then, annual adjustments to Social Security benefits depend upon whether there has been an increase from one year to the next in the CPI-W. Importantly, Congress requires that the decision be made by comparing what the cost of these goods and services was in the third quarter of the current year to the third quarter of the previous year. In other words, this is not a full 12-month, year-over-year comparison, but a comparison of two arbitrary points in time.
As retirees are well aware, even though the Consumer Price Index (CPI)-the most commonly cited measure of overall inflation-showed that from January 2015 to January 2016 the cost of living went up more than 2%, there was no cost-of-living adjustment (COLA) to Social Security benefits last year. That's because of the way Social Security is required to calculate its COLA.
When Social Security officials compared what it cost to buy everything in the CPI-W in the third quarter of 2014 and compared this to the 2015 price, the 2015 price was lower, thanks in large part to a (temporary) drop in the cost of energy. No inflation meant no increase in Social Security benefits in 2016 even though inflation went up 0.7% in 2015.4
The Retiree Double Whammy
Using the COLA for Urban Workers to determine Social Security benefit increases hurts retirees in another way. That's because it measures the expenses of working Americans-not the expenses that retired individuals have. Individuals under age 65 have different spending patterns than retirees. Because they generally spend more on housing and transportation, these categories get a higher weighting in the index. Working-age Americans spend less on medical costs, so this is a smaller weighting.
The result is that the CPI-W doesn't paint an accurate picture of the expenses individuals aged 65+ have-especially medical-related expenses. According to the National Committee to Protect Social Security and Medicare (NCPSSM), an advocacy group, seniors over age 65 spend twice as much as younger consumers on health care; for those 75 and older, the amount is almost triple.5
According to the NCPSSM, "over the past eight years, the current COLA formula has led to average increases of just over 1%, with three of those years seeing no increase at all. The 2017 COLA was a mere 0.3%. For the average senior, this COLA provided an extra $4 per month, barely the average cost of one Lipitor pill, a prescription drug frequently prescribed to seniors."6
This disconnect erodes the purchasing power of a retiree's Social Security check. It's why most senior advocacy groups have been lobbying for the government to create a special index that would more accurately reflect the spending patterns of those 62 and older. The Bureau of Labor Statistics (BLS) has actually had one for decades. In 1987, Congress passed a measure ordering the BLS to create an "experimental" CPI-E (E stands for elderly).
While it includes the same categories as the CPI-W, it has different weightings to more accurately reflect how seniors spend their income. For example, health-related spending in the CPI-E is 11%-twice the weighting it has in the CPI-W.
The AARP (a consumer advocacy group formerly known as the American Association of Retired Persons) found that from 1982 through 2004, the CPI-E generally (but not always) came in slightly higher than the CPI-W.7
Nonetheless, when you consider that a retiree could be collecting Social Security for 20-30 years, a fraction of a percent more per year adds up to a significant improvement over what may be two or three decades.
Still, so far, CPI-E has just been an interesting exercise. It is not being used to adjust benefits paid to Social Security recipients, federal employees or retired military. That would take an act of Congress-which just might be coming.
In April of this year, Congressmen John Duncan (R-Tennessee) and Dan Lipinski (D-Illinois) submitted "H.R. 2016: CPI for Seniors Act of 2017" to the House of Representatives.
The bill calls current measures of inflation "flawed and deficient" in terms of measuring how inflation impacts seniors because the current CPI-W is skewed toward a younger demographic. It states that the CPI-W does not include enough seniors in its sampling, focuses on products and services that seniors are not likely to purchase and completely overlooks seniors who live in rural areas.8 It is also faulted for not giving any consideration as to how seniors are affected by Medicare increases or income tax on their Social Security.
The authors of the bill point out that "senior citizens neither have the flexibility or the ability that younger consumers have to substitute necessary purchases in response to changes in prices, nor the same options as younger consumers have to supplement their income."9
If enacted, the measure would direct the BLS to create a new index called CPI-S (S stands for seniors) that specifically looks at the expenses of Americans age 62 and older. It would be a step toward recognizing the needs of seniors-and hopefully leading toward future benefit boosts that better reflect their realities.
Gail Buckner's comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Opinions and analyses are rendered as of the date of the posting and may change without notice.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the US, which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.
This information is intended for U.S. residents only.
Important Legal Information
All financial decisions and investments involve risk, including possible loss of principal.
The information (including tools) contained herein is general and educational in nature and should not be considered or relied upon as legal, tax, or investment advice or recommendations, or as a substitute for legal or tax counsel. It is not intended to serve as the primary basis for your investment, tax or retirement planning purposes, and should not be used as the final determinant on how and when to claim Social Security benefits, which can be a complex and personal decision. FTI is not responsible for content on the Social Security Administration's website. Federal and state laws and regulations are complex and subject to change, which can materially impact your results. Always consult your own independent financial professional, attorney or tax advisor for advice regarding your specific goals and individual situation.
- Centers for Medicare and Medicaid Services, "History of Health Spending in the United States, 1960-2013."
- Centers for Medicare and Medicaid Services, "2016-2025 Projections of National Health Expenditures Data," released February 15, 2017.
- US Social Security Administration, Social Security: Summary of Major Changes in the Cash Benefits Program, May 18, 2000.
- US Bureau of Labor Statistics, Consumer Price Index, December 2015.
- National Committee to Preserve Social Security and Medicare, "The CPI-E - A Better Option for Calculating Social Security COLAs," August 2017.
- AARP, "An Update on the Experimental Consumer Price Index (CPI-E) for Older Americans," 1983-2005.
- US H.R. 2016: CPI for Seniors Act of 2017.