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A reader from Michigan wonders about Social Security COLAs for ages 60-62 in high inflationary environments.
"I was born in 1961, so my average wage index year (age 60) was last year. Since your wages are all indexed until that year, they are then essentially frozen for two years until the Cost-of-Living Adjustments (COLAs) kick in at age 62. In this high inflation environment – say 8% this year and 5.9% last year – you could really fall behind someone born a few years earlier or later. Am I understanding this correctly?"
Another reader, this one from Ohio, asks a related question.
"My birthdate was in 1960, and my wife's was in 1958. It sounds like I (and maybe my wife) will not be receiving COLA increases during the highest inflation in 40 years. Is there a way to capture some of those inflation increases by starting my Social Security benefits this year (after I turn 62) instead of waiting until later, as planned? Would that 'kick in' any COLAs? Would some of the COLA increases offset the reduction in monthly payments? Thanks for your help in this time-sensitive issue."
Both readers are asking questions related to the same topic, something I brought up in a recent show.
This issue is not "time-sensitive" because, unfortunately, there is nothing you can do about it. It's not like you can fix it if you take some quick action. It’s just "how it is," and there is no fix unless Congress were to step in and intervene, but I doubt that will happen.
So, what is the issue? In calculating your Social Security retirement benefit, it all starts with your earnings record. Your earnings record can include 40+ years of earnings before you turn 62 when you first become eligible for Social Security retirement benefits. Well, they don't treat each year the same because that wouldn't be fair. Inflation exists in our world, so our earnings in our 20s are not the same, dollar for dollar, as dollars earned in our 40s, 50s or 60s.
Social Security adjusts for that first; they "index" your earnings based on wage inflation (which is a different measure than CPI). Wage inflation year-to-year can be higher or lower than CPI, but, on average, wage inflation in our society has historically been higher than price inflation (CPI).
[As an aside, that explains an increasing standard of living. If wages increased only at the rate of price increases, we'd still be living in the standard of the 1950s. But our wages have increased faster than prices, so we've been able to live a higher standard of living on average than in the decades before us.]
Wage inflation is used to effectively adjust all those earnings years into equivalent dollars in the year you turn 60. Why do they do this? Because when you turn 62, they must be prepared to pay out your retirement benefits because it's the first year you can apply and receive them. So they have to examine your earnings record. They picked age 60 as the last year that they index your earnings for various reasons, including delays in reporting.
They stop applying wage inflation, so any earnings after age 60 will no longer be adjusted for inflation. You may continue working into your sixties and beyond – and your earnings will add to your earnings record – but none will be adjusted for inflation before being placed into the earnings record itself.
So, what about the cost of living adjustments? Well, Cost -of-Living Adjustments, or COLAs, kick in once you become eligible for benefits. That's at age 62 when your base numbers (that stopped being adjusted in the year you turned 60) are still being used. Only in the year after that will you get your first COLA increase. And you will be credited for your COLA whether you claim your retirement benefits or not. Whenever you claim – whether it's at 63, 64, 65 or 70 – Social Security will adjust for the COLA from 62 to 63, 63 to 64 and so forth. You don't have to run out and claim at 62 to capture the COLAs. They happen automatically.
Both readers are concerned about the equivalent of a doughnut hole. In the Social Security setup, there are a couple of years where you're getting neither the wage inflation adjustment nor the COLA based on CPI.
Let's look at some examples.
If you were born in 1960, meaning you turned 62 this year, you didn't get the 5.9% COLA of last year (which was applied for 2022) because you weren't eligible for benefits. Now you're eligible for benefits based on your earnings record, so you will get the upcoming COLA which will be announced in October and applied next year when you're 63. But you missed the 5.9% COLA last year and didn't get the wage inflation adjustment the year before.
If you were born in 1961, you will take the biggest hit because you missed last year's 5.9% and will miss this year's 8.5% (or whatever it's going to be). So you will be missing out on over 13% indefinitely. Unfortunately, it's just the way it works. Because you're narrowly focused on specific years, it may seem unfair. However, it's a moving target, and Social Security looks at 40+ years of inflationary figures.
This 2-year period – where the Social Security setup causes you to receive neither the wage inflation adjustment nor COLA – happens to everybody. It has always gone under the radar. But what brings this reality to people's attention now is that we're seeing inflation not seen in 40 years.
So far, this only affects people born in 1960 and 1961, with those born in 1961 being the unluckiest because of the two years of high inflation. It's like winning a negative lottery. But if high inflation rates continue (or even increase) – which we hope they won't – it would also affect those born the following year.
It's no more than the luck of the draw. It's a 2-year "miss" where there's nothing proactive you can do to avoid it or fix it because it's not based on any actions you take. It's based on the year you turn 62 which, in turn, is based on the year you were born. So, for example, someone born in 1958 will not be affected, thanks to the low inflation rate when they turned 60. Therefore, their two years in the doughnut hole will not affect their benefits materially.
It's two years in a long timeline – COLAs will be granted from age 62 to death, which could be another 30+ years. But for those whose 2-year window lands in high inflationary times, it's a loss that all future COLAs can never quite make up. Unfortunately, it's the way the system works.
What's surprising is that we see very little explanation – or apparent concern – about this issue in the press or elsewhere. Over eight million people were born in the U.S. in 1960 and 1961 [Source: https://www.infoplease.com/us/population/live-births-and-birth-rates-year ], so this issue will have a marked impact on the retirement benefits of many people, including our two readers.