Personal Finance

2 Things That Hurt Social Security’s Inflation Protection

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A key feature of Social Security benefits is that they are adjusted annually to keep pace with inflation, helping prevent their buying power from eroding over time.

In fact, given the inflation we’ve seen so far this year, the cost-of-living adjustment (COLA) for 2022, which will be announced in October, could be the largest in four decades.

But the inflation adjustment really only helps your gross, or total, Social Security benefit amount keep pace with inflation.

Your net benefit amount — meaning how much money you actually have left after Medicare Part B premiums and federal income taxes — likely has not kept up with inflation, based on a new report from the Center for Retirement Research at Boston College.

This is because two factors that directly affect your net benefit — Medicare Part B premiums and federal income taxes — undermine the inflation protection offered by the Social Security COLA.

Medicare Part B premiums are outpacing overall inflation

Medicare is the federal health insurance program for seniors and people with certain disabilities and diseases. Part B is the component of Medicare insurance that covers doctor visits and other outpatient services, and Part B premiums generally are paid by being withheld from Social Security benefit payments.

The thing is that Part B premiums aren’t tied to the Consumer Price Index, the federal government’s system for gauging inflation, like the Social Security COLA is. These premiums are tied to the Medicare program’s per-person cost, which has been rising faster than overall inflation.

Between 2000 and 2020, the average annual Social Security COLA was 2.2%, whereas the average annual increase in the Part B premium was 5.9%, according to the Center for Retirement Research report.

“[R]ising Medicare premiums mean that a larger and larger chunk of the Social Security benefit goes to health insurance, so the net benefit available for non-health expenditures does not keep pace with inflation,” write report authors Alicia H. Munnell, CRR director, and Patrick Hubbard, a CRR research associate.

Social Security income tax thresholds are not adjusted for inflation

You may owe federal income taxes on your Social Security benefits if what the federal government calls your “combined income” is $25,000 or more and you file a federal tax return as an individual, or if your combined income is $32,000 or more and you file a joint return.

These thresholds have not changed since Social Security income first became taxable in 1983. That is to say, they have never increased to account for inflation or rising wages.

As a result, an increasing number of Social Security recipients owe federal income taxes on their benefits, which means lower net benefits for them.

In 1983, only 8% of eligible households paid taxes on their benefits. Today, an estimated 56% do, according to CRR.

Munnell and Hubbard continue:

“Under moderate inflation, that percentage is projected to increase to 58 percent in 2030. If inflation rises faster, Social Security benefits will be even higher in nominal dollars and more families will pay on more benefits — further reducing the net benefit.”

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