Most years, retirees receive a Cost-of-Living Adjustment (COLA) to their Social Security benefits. Social Security recipients often look forward to the COLA announcement, which is happening in October. In fact, projections are made throughout the year so seniors can anticipate how big their benefits bump will be.
Although it's natural to be excited at the idea of getting more money, the reality is that there are a few harsh truths about this COLA that seniors need to come to terms with. Here's what they are.
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1. It's not really a raise
The first thing you should be aware of is that the COLA is not really a raise, at least not in any traditional sense of the word.
While most people refer to the COLA as a raise, it's actually a benefits increase solely meant to keep pace with the impact of inflation so you don't lose buying power. Unlike when you get a raise at work to reward performance and increase your standard of living, this is only meant to keep you from losing ground.
Because of this, you don't actually want to root for a large Social Security benefits increase. A big benefits bump means inflation is very high. That's not good for your 401(k) or your other savings. After all, most seniors invest the money in their retirement plans relatively conservatively, so these other funds may lose buying power when inflation is surging.
2. Medicare premiums will come out of it
There's another key thing to be aware of when it comes to your Social Security benefits. Your Medicare premiums are typically withdrawn directly from your benefits. This means that you likely won't see your check increase by the full amount of the raise.
Say, for example, that your benefit increase is 2.7% and you're collecting $2,000. You'd receive a raise equal to $54 per month. If your Medicare premiums go up by $21 per month, though, you'll only end up getting an extra $33 in your check.
3. It may be calculated using a faulty formula
Finally, the last thing you need to know is that your COLA may not actually do a good job of helping you to avoid the loss of buying power, even though that's the entire purpose of it.
That's because your COLA is calculated by looking at changes to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). CPI-W measures the cost increases of a basket of goods and services used by, unsurprisingly, urban wage earners and clerical workers.
Most seniors are neither urban wage earners nor are they clerical workers, and they spend very differently from people within these demographic groups. Retirees tend to spend more on housing and healthcare, and those are areas where prices often increase faster than inflation. So, the benefits formula likely undercounts their raise.
These are, unfortunately, all facts that seniors should come to terms with sooner rather than later. Don't anticipate that your COLA is going to give you extra money to spend, and, in fact, keep in mind that even with a raise, your buying power may not stay the same.
You'll need to continue to monitor your budget and stick to a safe withdrawal rate on your savings to preserve your financial security for the future.
