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Is there really a two-year inflation ‘donut hole’ with Social Security? 🧐
With all the attention given to the latest Social Security COLA, I’ve been getting lots of questions.
Among the questions is about the alleged donut hole for Social Security inflation adjustments for individuals 60 and 61 years of age. Some in this cohort are upset that they may be missing out on significant benefits increases during this high inflation period.
This is based on the observation that if all wages are indexed through age 59, and the COLAs don’t start until 62, there are two years of no inflation.
While this is partially true, it’s not as bad as it seems. To get the full picture, let’s review how inflation affects a benefit.
First, there is the average wage index (AWI). The AWI controls two pieces of the PIA calculation:
→ The indexation of prior earnings through age 59
→ The increase of the bend points in the PIA formula
Second, there is the cost of living adjustment that begins applying to benefits at age 62. These adjustments are based on price inflation as measured by the CPI-W.
So if the COLAs don’t start until 62, and the indexation of earnings stops at age 59, it certainly does seem that ages 60 & 61 do not receive any adjustments through either wage-based inflation or price-based inflation.
But let's dig a little deeper and look at each age:
At 60, the average wage index level is used to determine two separate pieces:
▸ All prior earnings will be indexed based on the AWI level in the year someone attains 60. So, a higher (or lower) AWI in that year directly impacts the indexation of prior earnings.
▸ The AWI from the year someone attains age 60 will determine the PIA formula which will be used at age 62.
Thus, the wage index level at age 60 most certainly makes a difference!
At age 61, an individual receives no COLA and the AWI has no bearing on the future benefit.
At age 62, the COLAs start.
So...there IS a donut hole, but only for those who are 61.29 October 2022
The forecast of a 2034 depletion of the Social Security trust funds (from the 2022 Trustees report) was based on a 2022 COLA of 3.8% and a 2021 AWI increase of 5.6%.
Now we know that the COLA was 8.7% and the AWI was 8.89%.
Obviously, this means that more benefits are going to be paid out than expected.
As an offset to this, the maximum taxable earnings will also increase by more than expected so revenue from Social Security taxes will be somewhat higher than anticipated (as long as the employment rate holds steady).
The 2023 report is going to be fascinating!23 October 2022
Clients turning 62 in 2023 shouldn't be bummed out about missing the 8.7% COLA. Due to the increase in the average wage index, and the resulting formula and indexing increase, their benefit will actually be increasing by ~8.9%.18 October 2022