Image source: Social Security Administration. 

Millions of people rely on montly benefits checks from Social Security, the financial backstop that's primarily designed to provide income protection to low-income retirees but also provides benefits to survivors of deceased workers and the disabled. At the end of 2014 there were more than 59 million people receiving benefits, including almost 42 million retirees.

Unfortunately, many of these beneficiaries, as well as future beneficiaries, are facing quite the dilemma. The primary concern is that the Old-Age, Survivors and Disability Insurance Trust, or OASDI, is forecast to burn through its cash reserves by 2033. Assuming Congress is unable to find a way to increase revenue into the OASDI, cut expenses, or offer some combination of the two, Social Security benefits could drop by as much as 23% within the next 18 years. For the baby boomer generation, which is liable to be heavily reliant on Social Security due to its overall poor savings rate, and recent low-income retirees who are looking at life expectancy rates lengthening on an almost yearly basis, the prospect of a benefits cut in the future is downright frightening.


Image source: Flickr user Barkbud. 

Thanks for nothing, Social Security!
However, current beneficiaries don't have to look 18 years into the future to be worried. In fact, all they need to do is look at the latest correspondence from the Social Security Administration to be frightened. According to an announcement earlier this month by the SSA, there will be no benefit increase in 2016 for eligible beneficiaries, or for the more than 8 million people currently receiving Supplemental Security Income.

The SSA bases its decision on its cost-of-living adjustment, or COLA. The COLA is determined by comparing the average Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W, for the current year's third quarter with the prior-year third quarter, which is viewed as a baseline. Any increase over baseline is rounded to the nearest tenth of one percent, and represents the amount of increase beneficiaries can expect in the upcoming year. This is why Social Security beneficiaries don't find out whether they're due a benefit increase until October each year.

In the third quarter of 2014 the average CPI-W reading was 234.24, whereas in the third quarter of this year the average CPI-W actually fell to 233.28. Social Security beneficiaries are protected from seeing their benefit drop, but for the third time since 2010 there will be no increase in their benefits in 2016. The primary culprit for the CPI-W falling was a nearly $0.90 decline in per-gallon gas prices on a year-over-year basis.


Image source: Federal Reserve Bank of New York. 

This is a big deal
On the surface it might seem like the lack of a benefit increase isn't too big of a deal since overall inflation has been relatively tame. However, this may not be entirely true.

The big issue is this: the CPI-W may not accurately reflect the spending habits of seniors. As a percentage of their expenditures, seniors spend more on housing, and substantially more on medical care, than the typical worker who would be more accurately profiled by the CPI-W. Instead, the Consumer Price Index for the Elderly, or CPI-E, shows that housing contributed to 44.5% of seniors' expenditures as of Dec. 2011 compared to only 39.2% under the CPI-W. Likewise, medical care accounted for double the percentage of expenditures in Dec. 2011 (11.3% versus 5.6%) for the CPI-E compared to the CPI-W. The CPI-W tends to place an increased focus on transportation costs (ahem, gas!), food and beverages, apparel, and education and communication, which clearly don't have as much bearing for seniors.

The other issue here, as highlighted by the Chicago Tribune, is that millions of retirees will likely face higher Medicare costs because of the lack of a benefits increase in 2016.

A majority of Social Security beneficiaries pay their Medicare Part B premiums (the portion of Medicare that helps to cover the cost of outpatient care visits) directly from their Social Security payments. In the event of no COLA increase, a federal law kicks in that protects these beneficiaries from seeing their benefits reduced as Medicare Part B premiums rise, essentially freezing premiums. However, new Medicare beneficiaries, retirees with higher incomes, and consumers who don't deduct Part B payments directly out of their Social Security payments will see an increase next year. This increase, which is normally spread across all beneficiaries, will instead be spread across only 30%, meaning they'll bear the brunt of an expected $54 per-month increase (and it may be higher for wealthier individuals).


Image source: Social Security Administration. 

A fix is needed, but it too is not perfect
The reality is that a fix is needed to help seniors earn more from Social Security, and to keep them from experiencing these "zero-growth" years. Just because seniors aren't getting a raise doesn't mean that rent, property taxes, and prescription drug costs aren't rising.

The solution is actually pretty simple, but it's not perfect. Replacing the CPI-W with the CPI-E would better align the spending habits of seniors with Social Security. It's true that not all beneficiaries are seniors, but with roughly 70% of recipients being 62 or older, a fair case could be made that the CPI-E is a far more accurate indicator for the SSA to use when established its COLA in the third quarter each year. Presumably using the CPI-E should result in a benefit increase for beneficiaries since there would be more correlation to housing and medical care costs, which are what really matter to seniors.

But there's another side to this issue. The CPI-E only factors in households with consumers ages 62 and up. On the other hand, the CPI-W has millions upon millions of additional households that help establish the inflation rate since a majority of Americans are below the age of 62. Long story short, the CPI-W is actually a far better measure of inflation than the CPI-E.

Also, Medicare Part A, the component of Medicare that covers hospital coverage for the elderly, isn't factored into the CPI-E. Part A costs can be substantial for some seniors, and arguably could be their highest costs from a medical perspective. Not having this component factored into the CPI-E means switching to the CPI-E may still undercut the income needs of seniors.

It's clear there's still a lot of work left to be done. Regardless of whether you're retired or still working, Social Security probably affects you, and it's in your best interest to pay attention to what changes are coming down the pipeline. Remember, it's never too early to start preparing for your retirement.

Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

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