Obama's Budget Preserves COLA for Social Security: What it Really Means to Seniors

Seniors may have dodged a Social Security cost-of-living adjustment reduction this year, but an underlying question remains: how much the elderly pay for health care and what Social Security can do better to help address those costs. Read on for more.

Mar 8, 2014 at 11:00AM

Despite a narrow brush with a new reduction to Social Security benefits, seniors will not see the proposed move to a more conservative cost-of-living adjustment, or COLA, in 2014.

President Barack Obama's announcement on Feb. 2 that he was scrapping the earlier proposal preserves the status quo for seniors -- for now. The grand budget compromise it was supposed to prompt did not materialize.

The back and forth on COLAs, however, is not resolved. It is deeply linked to larger issues of what we mean when we talk about inflation and expenses for the elderly. Let's look at the landscape, as it stands, and what hasn't yet been addressed when it comes to COLAs and seniors' costs.

COLA: What actually (almost) happened -- CPI-W versus chained CPI
Obama originally sought last year to link Social Security's COLAs to a more conservative measure of inflation. Currently, Social Security is pegged to a consumer price index known as the CPI-W. It's a broad measure of merchandise costs, and it's categorized by a demographic that includes urban wage-earners and clerical workers. It measures many goods, sold in many places, over time. The idea is that the COLA given under Social Security changes to keep pace with trends in the costs of these goods under this index.

There is, however, more than one consumer price index. And the president proposed a switch from CPI-W to the "chained" CPI. It's called "chained" because while it's linked to shifts in the prices of different kinds of goods, it often refocuses to lower-cost (and perhaps lower-quality) goods to account for the fact that consumers tend to buy cheaper goods in an inflationary environment. One upshot of this difference is that the chained CPI can suggest a lower rate of inflation than the CPI-W.

And that's no small change.

The Center for Economic and Policy Research put it this way: If we start measuring the growth of inflation by the smaller numbers of the chained CPI, the average worker retiring at age 65 would see a reduction in benefits of about $650 each year by age 75. The reduction grows to roughly $1,130 annually by the time you reach age 85.

What's at stake: Seniors and the cost of health care
For now, there will be no downward change in the COLA for Social Security. A deeper problem looms, however. Are we measuring how we allocate Social Security COLAs to seniors in a way that makes good sense, in light of the things they pay for the most?

According to the Bureau of Labor Statistics, the goods people over the age of 62 buy are different from what people in their 20s and 40s tend to purchase. Consider, for example, the weight of health care in the equation.

Rather than rank medical services' relative importance at about 6%, as the CPI-W does, CPI-E tells us that for seniors it should be considered nearly 15% of total expenditures.

Typical Social Security benefits of $1,269 per month don't take you very far in paying for doctors and hospitals. A lifetime of health care for an average recipient living to 95 can rise as high as $318,800.

And, generally speaking, that number represents what's paid after Medicare covers its part of the bill -- with seniors' private health insurance or other resources helping to cover the rest. And then there are the Part B and Part D premiums to consider.

Money for medical services clearly has to come from somewhere other than just Social Security -- the benefits of which account for at least 50% of annual income for two-thirds of seniors, and for 90% among one-third of them. So, private health insurance, savings, investments -- these are important factors as well. There might, however, be a better way to represent how COLAs augment those resources that seniors do have: the CPI-E.

Rather than peg COLAs to the cost of goods that people in their 20s and 40s buy, the still-experimental consumer price index for the elderly emphasizes the importance of the kind of goods and services that seniors use most. Like health care.

So why don't we use it?

One does find the CPI-E lurking, now and then, in proposed bills. A recent inclusion: Senator Mark Begich (D-Alaska) made CPI-E part of his Protecting and Preserving Social Security Act, in 2013. The legislation has been sitting in subcommittee since April 2013.

Some might tell you that fiscally conservative politicians are more interested in cutting benefits programs than expanding them. Others could point to the CPI-E's experimental status -- suggesting that until the Bureau of Labor Statistics receives the funding to fully build out the index, uncertainty about its effectiveness remains.Whatever the nature of the process, however, it doesn't alter what is at the core of the CPI-E option: More accurately measure the consumer behaviors of the demographic receiving benefits that are attached to inflation, and you'll allocate their COLAs with more accuracy as a result.

And that would remove some of the pressure from seniors when it comes to proposals such as Obama's recent plan, which would give them less to pay for the things they use the most, all because less significant purchases are still the standard by which their cost of living is measured.

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James O'Brien is a WiserAdvisor contributor.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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