How COLA affects Social Security benefits

In anticipation of the largest cost-of-living adjustment in nearly 40 years, one financial adviser asked whether he should urge his clients to claim Social Security now to lock in the annual benefit boost next January, which could top 6%. I assured him that that was not necessary as anyone who is age 62 or older in 2022 and who is eligible for Social Security will profit from next year’s COLA — even if they have not yet filed for benefits.

“You are eligible for annual cost-of-living benefits increases starting with the year you turn 62,” according to the Social Security Administration publication Your Retirement Benefit: How It’s Figured. “This is true even if you don’t file for benefits until your full retirement age or even age 70.”

SSA increases your benefit beginning with the year you reach 62, and benefits are increased yearly to reflect the increase, if any, in the cost of living as measured by the consumer price index.

Social Security retirement benefits are based on an individual’s average lifetime earnings. SSA calculates your average monthly earnings during the 35 years you earn the most and indexes those earnings to account for changes in average wages since the year the earnings were received.

If you work fewer than 35 years, SSA includes zeroes in the 35-year calculation to account for those non-covered years, reducing your average lifetime earnings and consequently your future Social Security benefits. But you can continue working and adding to your earnings record, regardless of your age, even if those additional years of work occur after you claim benefits. You must have at least 10 years of covered earnings to collect Social Security benefits.

SSA then applies a formula to those average indexed earnings to calculate your basic benefit or “primary insurance amount.” That is how much you would receive if you claimed Social Security at your full retirement age.

You can choose collect benefits as early as age 62, but your benefits would be permanently reduced, and you would be subject to earnings restrictions if you continue to work if you claim benefits before your full retirement age.

For every year you postpone claiming benefits beyond your full retirement age up to age 70, your benefits increase by an additional 8% per year. So someone whose full retirement age is 66 could increase their benefits by 32% by waiting four years, until age 70, to claim Social Security. Anyone who was born in 1960 or later has a full retirement age of 67. Their maximum delayed retirement credit would be 24% if they postponed benefits for three years up until age 70.

Although the official COLA for 2022 will not be announced until October, continued inflationary pressure as the economy recovers from the pandemic-induced recession means that next year, Social Security recipients could receive the biggest increase in benefits since 1983.

Based on the July CPI released Wednesday, which increased 5.4% over the previous 12 months, the Senior Citizens League projects that Social Security benefits could rise by 6.2% in 2022.

The cost-of-living adjustment formula is based on the rise in the average CPI for the third quarter of 2021 over the previous year’s third quarter. The CPI data for July, August and September will determine the official cost-of-living increase for 70 million Americans starting next January.

“Now, with one-third of the data needed to calculate the COLA already in, it increasingly appears that the COLA for 2022 will be the highest paid since 1983, when it was 7.4%,” said Mary Johnson, a Social Security policy analyst for The Senior Citizens League.

While retirees may cheer a substantial increase in their monthly Social Security benefits after a decade of generally meager increases, there is also a downside to a big COLA.

Because of the way Social Security COLAs are calculated, benefits are only increased if the average CPI for the third quarter of the current year exceeds the average CPI for the third quarter of the previous year. That can be a high hurdle.

For example, when Social Security benefits increased by a whopping 5.8% in 2009 due to a temporary spike in gasoline prices in the summer of 2008, it took three years — until 2012 — before Social Security beneficiaries received another boost in monthly benefits. There was no COLA in 2010 or 2011.

An increase in the Social Security cost-of-living adjustment also triggers two other increases: the cap on the amount of wages and self-employment income subject to Social Security payroll tax and the retirement earnings test exempt amount that beneficiaries can earn without forfeiting any benefits if they claim Social Security before their full retirement age.

A 6% COLA could boost the maximum taxable wage base from the current $142,800 to more than $151,000 in 2022 and could increase the exempt earnings amount from this year’s $18,960 to more than $20,000 for those who claim benefits early while continuing to work next year.

[Questions about Social Security rules? Find the answers in Mary Beth Franklin’s ebook at Maximizing Social Security Retirement Benefits]