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Mark Miller: Remaking Retirement

Social Security Cost-of-Living Adjustment Looks Uncertain

The outlook for inflation and Medicare premiums complicates predicting what the net COLA will be for 2022.

Retirees listen carefully every fall for two important numbers that impact their pocketbooks for the year ahead: the Social Security cost-of-living adjustment, or COLA, and the standard premium for Medicare Part B, which covers outpatient services.

Right now, the outlook for both of those figures in 2022 looks highly uncertain.

The recent surge in inflation has some forecasters predicting a very hefty COLA next year. But the final number will be decided by monthly data during the third quarter for the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W.

We will know the Social Security COLA in mid-October, but the 2022 standard premium for Medicare Part B will be equally important this year. That figure generally is announced sometime later in the fall.

If you're enrolled in both Social Security and Medicare, you don't know your net COLA until both numbers are unveiled, since the Part B premium is deducted from your Social Security benefit. Typically, some portion of the COLA is gobbled up by higher Part B premium costs--sometimes, quite a bit of it, since healthcare prices usually rise at a much higher rate than general inflation.

This year, several unique factors make it nearly impossible to predict the size of the Part B premium hike--and it could be a big one.

Inflation

Consumer prices have been surging this year. Many economists regard this as a temporary increase, driven by distortions in the economy caused by the pandemic. In particular, the economic shutdown last year produced a drop in consumer prices, and the government inflation reports measure current inflation indexes against figures that were artificially depressed. And any forecast on inflation probably should be regarded with suspicion, since the track record among economists and in the market isn't good.

Still, the widely watched Consumer Price Index for All Urban Consumers, or CPI-U, increased 5.4% during June from a year ago, the highest 12-month rate since August 2008. The COLA is calculated using a slightly different measurement, the CPI-W. That indicator jumped 6.1% over the past 12 months.

If the CPI numbers remain high beyond the summer, the Social Security COLA will be large because of the formula used to determine the number each year. Social Security averages the CPI-W readings for each month of the third quarter, and compares those with the same data points from the year-ago period to arrive at the COLA. (You can see the details on how Social Security calculates the COLA here.)

Last year, those aforementioned pandemic-related declines in consumer prices persisted well into the summer, so it is very possible that this year's third-quarter comparison will produce a big COLA for 2022.

The Senior Citizens League, which tracks this data closely, is forecasting a 6.1% COLA for next year--although it cautions that the figure could still change significantly owing to the volatile data. My Federal Retirement, which tracks the COLA for purposes of federal benefit programs, thinks the adjustment will be 5.1%. (Social Security and federal benefit COLAs use the same formula.) A COLA anywhere in that range would be a very substantial increase from the 1.3% increase in 2021 or the 1.6% COLA in 2019.

Impact of the Part B Premium

Even in a normal year, the Part B premium cuts into the COLA to some extent.

Let's say the COLA for next year comes in at 4% and the Part B premium rises 5%, from $148.50 monthly this year to $156 (a difference of about $7.50) monthly next year. If your monthly 2021 Social Security benefit is $2,000, your gross COLA of $80 per month would be trimmed to $72.50. Looked at another way, the 4% COLA is reduced to 3.63%.

In years when the COLA is very low, a "hold harmless" feature of federal law kicks in. This is designed to ensure that net Social Security benefits do not fall. If the dollar amount of the Part B hike exceeds the dollar value of your COLA, your benefit simply stays flat for the coming year.

But this is not a normal year. Several unique wild cards make the Part B increase very difficult to predict.

Congressional action in 2020: This year, the Part B premium rose by just $3.90, to $148.50. But the increase actually was on track to be much larger. Congress stepped in with a one-time-only move to cap the increase at 25% of whatever it would have been if Medicare had followed the usual formula, as part of a COVID-19 relief bill. That could set the stage for a larger "catch-up" increase this year.

Healthcare utilization: Despite the big surge in healthcare use associated with COVID-19, overall consumption of healthcare services by seniors (and others) fell dramatically during the lockdown last year. A key question is how this will impact utilization of services by Medicare enrollees next year. Utilization--and costs--could be higher than normal as we adjust.

The very expensive new Alzheimer's drug: In June, the Food and Drug Administration approved a new Alzheimer's medication, Aduhelm (aducanumab), that is expected to cost a whopping $56,000 per year per patient. The drug will be administered in physicians' offices or a hospital setting, and thus will be covered under Part B rather than the Part D prescription drug program.

This was a very controversial drug approval, as many experts have doubts about Aduhem's effectiveness. But the impact on Part B finances is expected to be very substantial. Although it is difficult to forecast actual usage and costs, the Kaiser Family Foundation notes that if just one fourth of Medicare beneficiaries who used any of the currently available Alzheimer's treatments covered under Part D were prescribed Aduhelm, that would translate into spending of $29 billion annually. Putting that in context, total Part B drug spending in 2019 was $37 billion.

Medicare typically covers FDA-approved drugs, but it does have the right to make its own decisions about what to cover and for whom. Juliette Cubanski, deputy director of Kaiser's program on Medicare policy, says, "It's expected that Medicare will cover this drug, but will that mean for all patients with an Alzheimer's diagnosis, or only those who are in the early stages of the disease?"

Indeed, just last week, the FDA narrowed its own recommendation for prescription of the drug, saying it should be used only with patients who have mild cognitive impairment or early dementia.

Medicare's trustees will need to assess the likely spending on Aduhelm in 2022 and build that into the Part B premium. But the story on COLA and Part B might not end there. If inflation cools off in the third quarter and Medicare announces a large Part B increase, we might yet see a year when many beneficiaries fall under the "hold harmless" umbrella. That seems unlikely right now, but it can't be ruled out.

Or, if the trustees set a large increase in the premium, Congress might decide to intervene with legislation that blunts the increase--something that isn't difficult to imagine considering that 2022 is a midterm election year.

If that happens, the final numbers for Part B--and the Social Security COLA--might not be known until the very end of the year, or even early next year.

"It's going to be complicated, and it could drag out until the end of the year," Cubanski says.

The COLA: A Final Thought

Seniors have been known to get worked up about the COLA, arguing that it's too small, or that it doesn't reflect the actual inflation that they experience. (I haven't yet run across anyone who complains about a too-large COLA.)

The Senior Citizens League calculates that through the end of March, Social Security benefits lost 30% of buying power since 2000--and the erosion will deepen if inflation continues to rise this year.

The Senior Citizens League publishes a buying-power study that examines 39 expenditures that are typical for people ages 65 and up, comparing the growth in the prices of these goods and services to the growth in annual COLAs. Of the 39 items analyzed from 2000 through March 2021, 27 exceeded the COLA, while 12 were lower than the COLA.

Many Social Security reform proposals call for replacing the CPI-W benchmark with an alternative measure that is more sensitive to the type of consumer price changes experienced by seniors, called the Consumer Price Index for the Elderly, or CPI-E. Studies show the CPI-E would, on average, increase COLAs by one tenth of a percent annually.

That may not sound like much, but it would become more significant over time as the higher COLAs compound.

It may be the case that the COLA doesn't keep pace with inflation over long periods of time. But from year to year, the adjustments can be bumpy, and that's what we're seeing now.

Still, it's worth remembering that the annual COLA is one of the most valuable features of Social Security, because it aims to keep seniors even with inflation. Inflation adjustments were not part of the original Social Security Act of 1935--Congress added them through amendments in 1950. Even then, inflation adjustments were awarded only sporadically according to the whims of Congress. The automatic annual adjustment was introduced in 1975.

Along with retirement benefits, the COLA is used to adjust Social Security disability benefits and Supplemental Security Income. It also is used to adjust the cap on wages subject to the payroll taxes that fund Social Security.

The COLA is fairly unique among the various types of retirement benefits in our system. Many public-sector defined-benefit pension plans feature COLAs, and you can buy inflation protection with some annuities. But for most of us looking for retirement income with built-in inflation protection, Social Security is the only game in town.

Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to The New York Times and WealthManagement.com. He publishes a weekly newsletter on news and trends in the field at RetirementRevised. The views expressed in this column do not necessarily reflect the views of Morningstar.