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Chained CPI and Social Security Benefits: How It Impacts You

Written by Jeff Rose on May 28, 2013 in Retirement  |   No comments

Many Americans will rely on Social Security benefits in retirement, but the way their benefits are calculated could be set to change. Currently, Social Security uses a cost of living adjustment (COLA) to determine how much retirees and other people in the program get paid…

retirementMany Americans will rely on Social Security benefits in retirement, but the way their benefits are calculated could be set to change.

Currently, Social Security uses a cost of living adjustment (COLA) to determine how much retirees and other people in the program get paid from year to year. During most years, the COLA adds money to recipients’ Social Security checks in an attempt to keep payments on pace with inflation.

The consumer price index (CPI) examines the weighted average of prices of consumer goods and services and is the measurement the government uses to determine fluctuations in cost of living. Those fluctuations inform COLAs made to Social Security.

Currently, the government uses two main CPIs: the CPI-U, the index for all urban consumers, and the CPI-W, the index for urban wage earners and clerical workers.

But there’s been discussion about switching to a chained CPI, and this change could significantly lower the amount of money that people receive.

What is the chained CPI?

Unlike the regular CPI, the chained CPI assumes that rising prices cause consumers to change their buying behaviors, substituting lower-cost versions of items for those they normally buy. The result is a lower annual inflation rate.

Thus, according to the chained CPI, rising prices don’t mean people on Social Security will need more money to afford the things they typically buy. Rising prices mean that people will change their buying behaviors by choosing lower-priced options.

Put simply, chained CPI means a lower COLA for people on Social Security.

How much will the chained CPI affect COLAs?

The Social Security Administration releases COLA information one year before changes take place, so it’s impossible to know exactly how much the chained CPI will affect COLAs. Some years, it might not make any difference—the Social Security Administration didn’t even make a COLA for 2010 or 2011 because inflation was so low. In such instances, the type of index used doesn’t have much of an impact.

However, it is possible to estimate how the chained CPI will affect Social Security COLA during years with noticeable inflation.

It’s projected that the Social Security Administration will distribute $1.4 billion less during the first year that it uses the chained CPI to determine COLA. Realistically, that’s not a huge change at the individual level, although even small changes can mean a lot to people struggling to get by on their Social Security checks.

Over time, chained CPI will have a cumulative effect. That’s where Social Security recipients should worry. Over the first decade, the average recipient would likely see a 3 percent drop in Social Security benefits. After 30 years, the recipient would get about 9 percent less than they would if the current CPI was used.

Other consequences of a chained CPI

There’s another consequence to using a chained CPI that many people don’t acknowledge. With a chained CPI, tax bracket thresholds will change more slowly than usual. That means people will pay higher taxes because they will be stuck in a bracket even as they get less money from Social Security.

This amounts to a tax hike that doesn’t force politicians to officially raise taxes. The Congressional Budget Office believes it will bring in $72 billion more without raising taxes.

There’s an argument to be made that using a chained CPI to determine Social Security COLA could make sense by encouraging people to make better buying decisions. Unfortunately, an individual’s buying habits don’t affect that person’s healthcare expenses because there are not many choices for cheap care. As Social Security primarily benefits the elderly, a lot of people could find that they don’t have enough money to pay for medical treatments, let alone lead fulfilling lives.

Jeff Rose is a Certified Financial Planner and Iraqi combat veteran. He blogs at Good Financial CentsSoldier of Finance and Life Insurance By Jeff.

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