Small COLA hike for Social Security recipients

(MoneyWatch) The federal government announced today that Social Security recipients will see only a 1.7 percent rise in the program's cost of living adjustment, or COLA, next year. That is less than the 3.6 percent increase beneficiaries got this year and is among lowest hikes since the U.S. government started making annual adjustments in 1975.

Retired workers on average collect $1,237 a month in Social Security payments, or roughly $14,800 a year. Raising the COLA 1.7 percent will add about $21 a month to those payments, or $252 for the year. 

Every year, the Social Security Administration's COLA announcement triggers a debate about the fairness of the mechanism that's used to determine the cost-of-living rise. Let's take a look at how the system works.

First, it's necessary to dispel a misconception: Politicians don't sit around a table each year deciding what the COLA will be. The adjustment is determined by a formula that's baked into the law governing Social Security. It's based on the change in the so-called "Consumer Price Index for urban wage earners and clerical workers" (CPI-W) from the third quarter of the previous year (in this case, 2011) to the third quarter of the current year. The CPI-W is determined by the Bureau of Labor Statistics, a part of the U.S. Department of Labor.

Under this formula, the Social Security COLA was zero for both 2010 and 2011, but rose to 3.6 percent for 2012.

Some analysts contend that the CPI-W understates the increase in living expenses experienced by retirees and that the benefits adjustment doesn't fully offset inflation. The primary bone of contention for such critics: health care expenses, which are rising faster than those of other goods and services and what are consuming a greater portion of average retirees' budgets, compared to wage earners.

In addition, the CPI-W is partially based on big-ticket items, such as refrigerators and cars, that retirees might not purchase as frequently as wage earners. One group of analysts, the American Institute for Economic Research, proposes an Everyday Price Index (EPI) that rises at a faster rate than the CPI-W.

On the other hand, some analysts contend that the CPI-W overstates the cost increase in items that retirees and other people buy. They point out that consumption patterns change over time and that when the cost of a specific item rises quickly, people tend to substitute cheaper items. For example, if the price of beef rises faster than the price of pork, people will eat more pork and less beef.

These experts favor using what is known as the "chained" Consumer Price Index, which would result in lower Social Security COLAs. Several politicians have proposed using the chained CPI as one way to slow future benefit increases and help shore up the Social Security program's finances.

What should retirees in response to these changes? We have no control over the law that governs Social Security increases, other than by using our voting power. And everybody's spending and cost of living is different. As a result, retirees can -- and should -- manage their own personal cost of living. They have more time than workers, so they can use their time wisely by buying when goods are on sale, shop around and make substitutions when that saves money.

Retirees also can take the time to eat better and exercise more in order to reduce the money they might spend on medical bills. And when they get sick, they can investigate the use of efficient medical providers or alternative treatments that cost less. For instance, they can look into using generic drugs that might be just as effective, but significantly cheaper, than brand drugs.

Retirees or people approaching retirement should start thinking long-term when it comes to their purchases. You should buy cars that will last and require relatively little maintenance. Better yet, start relying more on public transportation. To reduce utility bills, insulate your house, turn up the thermostat on the refrigerator, and turn down the thermostat on your space heater and hot water heater. Better yet, downsize your house to reduce utility bills and property taxes.

People can also grow some of their own food, eating fresh fruit and vegetable, and cutting down on expensive processed foods. Take a walk or bike ride every day to get exercise. Sign up for dancing lessons or a yoga class or water aerobics. Get out there and get active to improve your health.

By now, you get the picture. If you focus your time and attention, you can cut back on your own cost of living and make a positive difference in your life.

Image courtesy of Flickr user 401(K) 2012

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.