This week, Advisor Perspectives published my article entitled, “Social Security’s Short‑Term Crisis: What Advisor’s Must Prepare For.” The primary purpose of this article was to focus on possible solutions to the system’s short-term financing problems, not its long-term financial problems. One of the alternative solutions discussed in the article involved freezing cost‑of‑living increases (COLAs) for several years. While a temporary freeze is an efficient short‑term lever, it is also regressive and politically difficult. An alternative approach is to modify the COLA formula itself in a way that protects lower‑benefit retirees while moderating both short-term and potential long-term cost growth.
This post outlines a progressive COLA‑cap mechanism that accomplishes those goals.
- Concept: A Progressive COLA Cap
Under current law, COLAs are proportional to benefit size: every retiree receives the same percentage increase, so higher‑benefit retirees receive larger dollar increases. This structure is not inherently progressive.
A progressive alternative is:
COLA = the lesser of (CPI increase) or $X, but not less than Y% of the CPI increase.
This creates a dollar cap on the annual COLA. Low‑benefit retirees would typically receive full CPI, while higher‑benefit retirees receive a smaller percentage increase.
- Annual Redetermination of
To avoid arbitrary or outdated caps, can be recalculated each year:
where is the average retired‑worker benefit in the prior year or some percentage of the average benefit.
This ensures:
- Automatic scaling as benefits grow.
- Built‑in progressivity: retirees below the average benefit rarely hit the cap.
- Predictable savings tied to the benefit distribution.
- Determination of Y
Y determines the floor percentage increase applicable to beneficiaries with relatively higher benefit levels. This rate would be a lower percentage of the full COLA rate or even start at zero and gradually increase over the years depending on how much is needed to help solve the system’s short-term funding problem.
- Addressing Fairness for Early/Late Claimers
A potential fairness issue arises with this general proposal because delayed claimers have higher benefits due to actuarially fair delayed retirement credits. Under a simple dollar cap, they are more likely to be constrained even though their higher benefit is “earned.”
A refinement is to apply the cap test to:
where is the early/late retirement factor. This effectively bases the cap on the retiree’s PIA‑equivalent benefit, aligning the cap with lifetime earnings rather than claiming age.
This adjustment:
- Improves actuarial fairness.
- Removes behavioral distortions related to claiming age.
- Adds complication to the proposal.
- Example
Let’s assume Congress sets X at 50% of the average monthly benefit (assumed to be $2,000) for the preceding year and sets Y as 25% of the full COLA. The following table shows the COLAs for beneficiaries with various ERF-adjusted benefits assuming the full COLA is 3% under the proposal:
ERF-Adjusted Monthly Benefit | COLA |
$1,000 and below | 3% |
$2,000 | 1.5% |
$3,000 | 1% |
$4,000 and above | 0.75% |
- Short-Term or Long-Term Solution?
Depending on the X and Y chosen by Congress and the effective date of implementation, the proposal may not be as efficient as part of a short-term solvency patch as a COLA freeze, but it could be more effective as part of addressing the long-term problem.
A progressive COLA cap could directly affect post‑entitlement price indexing, which compounds over decades. The result is a structural flattening of benefit growth, concentrated among higher‑benefit retirees.
This makes the proposal well‑suited for inclusion in a comprehensive long‑term solvency package, alongside more modest tax adjustments or benefit formula changes.
- Summary
A progressive COLA cap:
- Protects lower‑benefit retirees from inflation erosion.
- Moderates long‑run benefit growth.
- Preserves political feasibility better than a COLA freeze.
- May provide more modest short‑term savings but offers significant long‑term compounding savings (depending on provisions adopted), and
- Can be refined using PIA/ERF adjustments to improve fairness.
