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Alicia Munnell: Changing Social Security COLA Index 'Not Worth the Effort'

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There’s a simmering question in retirement circles today: Should the inflation index that determines the Social Security cost-of-living adjustment be changed to tilt more toward what seniors spend in retirement, such as on medical care.

Probably not, says one of the most expert voices in the retirement business today, Alicia H. Munnell, director of Boston College’s Center for Retirement Research, in addition to being the Peter F. Drucker professor of management services at the school’s Carroll School of Management and a prolific author of books and articles.

Before joining Boston College in 1997, she was a member of the President’s Council of Economic Advisors for two years, and assistant secretary of the Treasury for economic policy from 1993 to 1995. Earlier, she spent 20 years at the Federal Reserve Bank of Boston and earned a Ph.D. from Harvard University.

As part of our VIP interview series, we asked Munnell five questions on current events and how they could affect investment portfolios and retirees going forward. Here are her emailed responses:

ThinkAdvisor: Inflation has jumped 7.9% over the last 12 months. Have you done any research that could help advisors prepare clients for either pre- or post-retirement portfolios with this threat?

The U.S. has not seen any serious inflation since the 1980s. This bout is likely to pass in a year or so, hopefully without pushing the economy into a serious recession.

The advice that I get from experts is decide on your asset allocation for the long run, and then pretty much stick to it.

2. The Social Security COLA, which was raised to 5.9% this year, is now lagging current inflation rates. What’s the best way for advisors to help retirees to counteract the crunch they are taking to their Social Security benefits (especially if they already are collecting benefits)?

Yes, the Social Security COLA lags a little because it is based on the third quarter of 2021 over the third quarter of 2020. But 5.9% compensates for a significant portion of current inflation.

As inflation recedes, the lag in the calculation means that beneficiaries will get more than the rate of inflation on the backside.

3. Do you have an opinion on whether the COLA index should be changed from CPI-W to CPI-Elderly? 

The underlying argument for a CPI-E is that older households spend more on medical care than their younger counterparts and the cost of medical care rises faster than other budget items.

In 2007 — the earliest year for which CPI-E weights are publicly available — the elderly spent more than twice as much on medical care relative to their total expenditures as the population as a whole.

What has changed is the rate of medical inflation. Healthcare costs are rising at a much lower rate than in the past. Since this low-inflation component receives twice the weight in the CPI for the elderly as it does in the CPI-W, the CPI-E increased more slowly.

In fact, this year’s COLA based on the experimental CPI-E would have been 4.8% compared with the actual COLA of 5.9%.

To me, shifting to the CPI-E to determine the COLA has never seemed like a productive proposal. First, the difference between the two indexes has declined over time.

More important, the CPI-E is not a real price index. It simply re-weights the data collected for the population as a whole.  As a result, it suffers from several flaws.

In short, fooling around with the index for Social Security’s COLA is not worth the effort. We have bigger fish to fry.

For more, see our brief: What Is the Right Price Index for the Social Security COLA?

4. What lessons can advisors/clients learn from today’s volatility mixed with higher inflation and the impact on portfolios? Have you done any research on what are the best products they should incorporate into portfolios now?

My response to this question is the same as for question No. 1: Select a diversified portfolio that is comfortable in terms of risk, and then pretty much stick with it. People generally lose out when they sell during turmoil or buy specialized products in response to a transitory phenomenon.

5. Do you believe that Congress will step up and make changes to Social Security, including making the appropriate funding, in the next couple years? Why or why not?

The depletion of the Social Security Trust Fund reserves is an important action-forcing event. Once the OASI trust fund reserves are depleted, revenues — primarily from the payroll tax — will be sufficient to cover only 76% of promised retirement benefits and 78% of total benefits.

It would indeed be wonderful if Congress enacted a plan to ensure the payment of full Social Security benefits for the next 75 years. Legislators have put forward a number of proposals that would both offer some enhancements and produce enough revenue to fill the financing hole. Congress should take up these proposals directly.