No need to claim Social Security to cash in on COLA

The 8.7% cost-of-living adjustment in Social Security benefits for 2023 has certainly garnered a lot of attention. Financial advisers across the country are getting questions from their clients about whether they should file for Social Security benefits now to cash in on the biggest annual increase in more than 40 years.

“How does the COLA affect the amount of Social Security benefits for a person who is delaying claiming benefits until age 70?” Julie Scott, a financial adviser from Alaska wrote to me via email. “I understand the standard 8% annual increase for delaying each year beyond full retirement age up to age 70,” Scott wrote. “But does the 8.7% COLA increase this even more?”

Yes, it does!

Lots of other advisers have similar questions.

“We have a number of people asking us if the published 8.7% cost-of-living adjustment in next year’s Social Security benefits applies to those people who are not yet collecting benefits,” an adviser from New Jersey wrote.

Al Lindsten, a financial adviser in Fort Wayne, Indiana, said he has a client who's currently 65 and still working. The client had planned to wait until 69 to claim Social Security, but now he’s rethinking that decision.

“He is questioning the logic of delaying his Social Security because he believes that he will get a bigger benefit if he claims now and gets the benefit of all the annual increases that are potentially bigger than the 8% annual increase for delaying his benefit beyond his full retirement age,” Lindsten wrote.

I would certainly caution Lindsten’s client not to claim Social Security now since he is under full retirement age and still working. His benefits would be permanently reduced for claiming early and he would be subject to earnings restrictions that could temporarily reduce some or all of his benefits even more.

But to all the advisers I offered some good news:

There is no need for clients to claim Social Security benefits now to cash in on the huge 8.7% cost-of-living adjustment for 2023. Every year that you are eligible for Social Security, beginning at age 62 and up to the time you claim benefits, each COLA is automatically applied to your future benefit, even if you haven't yet filed for Social Security. That's in addition to the delayed retirement credits of 8% per year up to age 70.

“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,” the publication states. 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.

Scott had another question: “Is the COLA built into the calculation that folks see on their online Social Security benefits page?”

No, the estimated benefits don't include annual cost-of-living adjustments. SSA can’t provide actual benefit amounts until an individual applies for Social Security. “And that amount may differ from the estimates because your earnings increase or decrease in the future and after you start receiving benefits, they will be adjusted for cost-of-living increases,” the standard SSA estimated benefits statement says.

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's 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.

In addition, 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.

(Questions about new Social Security rules? Find the answers in Mary Beth Franklin’s 2022 ebook at MaximizingSocialSecurityBenefits.com.)