Posted by: drdata921 | April 26, 2013

Will the Promises Be Kept – Social Security

What Does the “Chained CPI” Social Security Adjustment Really Mean to Seniors

Recently, President Obama submitted a budget to congress that would have clear and relatively quick impacts on the finances of retirees. He included proposals that would affect Social Security benefits. If you are a person in or nearing retirement, what does this mean to you?

In the budget proposal, annual inflation adjustments to Social Security benefits would be reduced. The mechanism is a move to the so-called “Chained CPI” method for calculating inflation. The logic is that the standard method for calculating inflation – the Consumer Price Index or CPI – over-estimates inflation. The rationale for this is that people adjust their purchasing to compensate for higher prices. To give you an example, if the price of beef rises, people will switch to cheaper alternatives (e.g. chicken). Hence, the real rate of inflation is actually less than the CPI estimates and the adjustment to Social Security should be less to reflect this.

Sounds reasonable, right? However, what are the implications? Current estimates say that moving to a chained CPI inflation adjustment for Social Security would shave about 0.25% off of the annual adjustment. If, for example, the CPI estimates inflation at 3%, the Chained CPI would drop it to 2.75%. Social Security checks would be adjusted upward by the 2.75%, not the 3%.

That doesn’t sound like much. However let’s do the math. At the end of a 30 year retirement, assuming an annual 3% inflation rate you would be receiving 6.8% less with the chained CPI. This assumes that you started with the average 2012 Social Security benefit of $1250/month. Over 30 years this would be a cumulative loss of over $28,000 in benefits using the Chained CPI adjustment. Some estimates put that difference as much as 9.4% less or over $38,000 in cumulative benefits lost to the average retiree. This number could be more or less depending on your starting benefit. So, what seems like a minor change can have significant ramifications when you look long-term.

From the government’s perspective this is one way to reduce the deficit. They estimate that over 10 years, savings would be about $341 billion. Of that, $127 billion would come from reductions in Social Security benefits, about $89 billion from other programs ( the social safety net), and $124 billion from tax bracket indexing.

Whoa, hold on for one minute. I understand the cuts to Social Security benefits, but what is this tax bracket indexing thing? Well, the CPI also is used to adjust the Federal Income tax brackets each year for inflation. This protects tax payers from being pushed into higher tax brackets because of inflation. If the Chained CPI adjustment is applied, you get less protection. So, as a senior you potentially could get a double whammy. First, you are collecting less from the Social Security benefit. Second, depending on your income, you could get pushed into a higher income tax bracket.

Now, I understand that the country is in a time of need. However, before you start getting too patriotic let’s do a reality check: Are the assumptions behind the Chained CPI correct?

• First, as prices go up, people shift their purchasing to lower priced alternatives. Nothing wrong with that assumption. This is exactly how consumers react. So, here I am in 2013 and I stop buying expensive beef and shift to cheaper chicken. However, fast forward to 2014 and inflation is up. I have already shifted to the less expensive options, but my Social Security check is under-compensating for inflation. Where do I go now? You see, the Chained CPI logic is very time bound and unless you have options to trade down to cheaper alternatives each year, it is a flawed logic. As a Social Security recipient, you could get into a deeper financial hole each year.

• Second, some economists have argued that the CPI adjustment that is used now, based on costs for urban workers, underestimates the rise in costs for seniors. That is because seniors disproportionately purchase goods and services that have inflation rates higher than the costs estimated by the CPI. An example of this would be health care and health care-related products. So, if the current CPI adjustment is under-compensating seniors for inflation now, a Chained CPI adjustment would only worsen the situation.

The move to a chained CPI may seem a bit technical and of minor consequence until you start running the numbers. Some are predicting a rather alarming rate of poverty among Boomers. These proposed Social Security changes will only make that situation worse. This is something that you need to think about!

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