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How Taxes, Medicare Premiums Erode Social Security Benefits Despite COLAs

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What You Need to Know

  • Yearly COLAs don't insulate households from inflation's erosive impact, the CRR says.
  • Medicare Part B payments typically take a chunk out of Social Security benefits.
  • Income levels above which benefits are taxed haven't been raised.

Retired clients collecting Social Security benefits get hit in two ways when it comes to inflation. First, the cost-of-living adjustment, or COLA, typically doesn’t keep up with Medicare payment adjustments, and second, income levels above which retiree benefits are taxed haven’t been raised to match price and income growth.

The combination, a Center for Retirement Research at Boston College paper states, means that inflation continues to eat away at Social Security benefits despite the yearly COLA.

The paper, The Impact of Inflation on Social Security Benefits, by Alicia H. Munnell, director of the CRR, and Patrick Hubbard, a research associate, notes that this year could see the largest COLA in nearly 40 years. And although that’s good, the paper highlights inflation’s erosion factor when it comes to Social Security benefits.

Medicare Premium Decay

As of the July consumer price index, the annual Social Security COLA is estimated to be 6.2%, the highest since 1983. The actual increase for 2022 won’t be released until October, and is based on the third-quarter average of the CPI (July was the first month of the third quarter).

The rub is that Medicare Part B premiums (for physician and outpatient services) are typically deducted from Social Security benefits before the check is sent to the recipient. And though, typically, benefits are increased each year, so too are Medicare Part B premiums.

And the difference is the issue: From 2000 to 2020, the average annual adjustment of the Medicare Part B premium has been 5.9%. But the average annual increase to the Social Security COLA has been 2.2% over the same period.

For example, the paper notes, if the average benefit is $1,900 per month and the Medicare Part B premium is $150, the net for the beneficiary is $1,750 to spend on food, shelter and other expenses.

But if the COLA rises 2.2% while the Medicare Part B premium rises 5.9%, the benefit would rise to $1,941, while Medicare Part B rises to $159, and a net benefit of $1,782 or 1.8% more than the original $1,750, which doesn’t keep up with the average inflation rate.

The authors state that this difference is more dramatic over a longer period of time. Over a 30-year period, while benefits may increase nominally from $1,900 to $3,600, or 89%, the net benefit rises $1,750 to $2,800 or 60%. Instead of a 2.2% annual increase, the net benefit rises only 1.6%.

The authors note that this impact is “even greater for high income individuals, because their premiums constitute a larger share of their Social Security benefits.”

Taxed Social Security Benefits

Currently, individuals making less than $25,000 (and married couples filing jointly making less than $32,000) pay no taxes on their Social Security benefits. Above those thresholds, recipients pay taxes on up to 85% of their benefits (on the difference between $25,000 and their adjusted gross income).

But these thresholds are not increased on “either wage or price growth,” the researchers state, meaning that every year, more beneficiaries are being taxed on their Social Security benefits.

The paper states that in 1983, when the tax on benefits was introduced, only 8% of eligible families had to pay taxes. Today, that has jumped to 56%. “Under moderate inflation, that percentage is projected to increase to 58% by 2030,” the authors note. This again shows an erosion of net benefits.

The researches conclude that these two factors undermine the automatic indexing provision of COLA, noting that first, “rising 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.”

Second, they state, “a personal income tax with unindexed thresholds for benefit taxation means that wage growth and inflation will subject an increasing portion of Social Security benefits to taxation.  … In short, even Social Security does not fully insulate older households from inflation’s erosive impact.”