The Impact of Inflation on Social Security Benefits

This fall, the U.S. Social Security Administration is likely to announce that benefits will be increased by around 6 percent beginning January 1, 2022. This cost-of-living-adjustment (COLA), which would be the largest in 40 years, is an important reminder that keeping pace with inflation is one of the attributes that makes Social Security benefits such a unique source of retirement income. A spurt in inflation, however, affects two other factors that determine the net amount that retirees receive from Social Security. The first is the Medicare premiums for Part B, which are deducted automatically from Social Security benefits. To the extent that premiums rise faster than the COLA, the net benefit will not keep pace with inflation. The second issue pertains to taxation under the personal income tax. Because taxes are levied on Social Security benefits only for households with income above certain thresholds ($25,000 for single taxpayers and $32,000 for joint returns) and the thresholds are not adjusted for wage growth or inflation, rising benefit levels subject more benefits to taxation – again reducing the net benefit. This brief explores the interaction of inflation and Social Security benefits. The first section describes the nature of the COLA. The second section looks at the interaction of Medicare premiums and the COLA. The third section explores how inflation affects the taxation of benefits. The final section concludes that, while the inflation adjustment in Social Security is extremely valuable, the rise in Medicare premiums and the extension of taxation under the personal income tax limits the ability of beneficiaries to fully maintain their purchasing power.