Since 1975, Social Security beneficiaries have received a cost-of-living adjustment (COLA) to compensate for inflation every year except 2010 and 2011. The good news is that a 3.6% COLA has been implemented for 2012. However, this “raise” may be reduced slightly by higher Medicare premiums, which are deducted directly from Social Security payments.1
How the COLA Is Determined 
The COLA is based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which measures the spending habits of workers who are generally younger than Social Security recipients. A recent study suggests that, while Social Security benefits increased 31% from 2000 to 2011, typical expenses for people aged 65 and older increased by 73%.2
One suggestion to address this disparity is to base the COLA on the CPI for Elderly Consumers (CPI-E), an “experimental” price index that the government has tracked since 1983.3 Although the CPI-E has increased somewhat faster than the CPI-W, the difference is relatively small. A monthly benefit of $1,000 in 2001 would have increased to about $1,268 in 2011 based on the CPI-W and $1,280 based on the CPI-E.4
Considering Social Security’s fiscal problems, a more likely change (proposed by two congressional commissions) is to lower benefit adjustments by tying the COLA to the slower-moving Chained CPI for All Urban Consumers (C-CPI-U), which attempts to track changes in spending patterns as consumers respond to price changes.5 If the $1,000 monthly benefit in 2001 had been based on the C-CPI-U, it would have increased to only $1,238 in 2011.6
Regardless of the index used, current and near-retirees are unlikely to see major changes to their basic benefits. It’s clear that Social Security should not be given too much weight in funding a comfortable retirement.
1) Social Security Administration, 2011
2–3) The Senior Citizens League, 2011
4, 6) Haver Analytics, 2011
5) Center for Retirement Research, 2011
If your IRA could write you a letter, this is what it would say:
