How the 2023 Cost-of-Living Adjustment Impacts Americans Living Abroad
Regardless of where you’re currently living, you’re likely aware that U.S. inflation is soaring. Not only that, but global stock and bond markets have been volatile, causing many investors to wonder, “What’s next?” One silver lining to the current economic situation is that Social Security beneficiaries are set to receive an 8.7% cost-of-living adjustment (COLA) in 2023, which is the largest COLA in more than four decades. If you’re a U.S. expat currently receiving Social Security benefits, or approaching eligibility, this is great news!
In this article, we answer common questions about how the Social Security Administration calculates the COLA and how the adjustment may impact your benefits and claiming strategy.
How is the Social Security COLA calculated?
The COLA is based on a subset of the Consumer Price Index (CPI) called the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). To determine the COLA, the Social Security Administration calculates the difference between the average price of the CPI-W in the third quarter of the current year and its average price in the third quarter of the previous year. The percentage increase is then applied to the upcoming year’s benefits. If the difference in the average CPI-W from one year to the next is 0% or less, a 0% COLA is applied to the following year’s benefits (the last year of 0% COLA was in 20161).
How does the COLA impact my Social Security benefits?
If you are already receiving Social Security, the COLA is automatically applied to your current-year benefits beginning in January. For example, if you received $2,500 in benefits per month in 2022, your monthly benefit beginning in January 2023 will increase to $2,717.50 ($2,500 x 1.087).
If you’ve reached age 62 and have not yet filed for Social Security, you will be eligible for the COLA; however, the calculation method is a bit different. The COLA applies to the primary insurance amount (PIA), which is the benefit amount you would be eligible to receive at your full retirement age (FRA). Your Social Security benefit estimates at different claiming ages are then based on your updated, COLA-adjusted PIA.
It’s also important to know that your Social Security PIA is calculated using your highest 35 years of earnings. Those earnings are also indexed for inflation. Therefore, future Social Security recipients who have not yet reached age 62 will experience an adjustment to their past earnings to reflect changes in average national wages and standards of living over time.2
How does my foreign pension impact the Social Security COLA?
If you qualify for Social Security retirement benefits and a retirement pension from a job in which you did not pay into Social Security, you may be impacted by the Windfall Elimination Provision (WEP). Under this provision, your pension would be considered “non-covered.” Many foreign pensions fall into this category. Generally, WEP reduces your PIA based on your years of substantial Social Security earnings. In addition, if your spouse is claiming a spousal Social Security benefit (up to 50% of the primary worker’s benefit), his or her spousal benefit would be based on your benefit after WEP has been factored in.
The good news is, even if you’re subject to WEP, you’re still eligible to receive Social Security COLAs. Also, survivor benefits are not affected by WEP, which would be removed for your spouse or other family members if you were to pass away. Finally, if you have 30 or more years of substantial Social Security earnings, you are not subject to WEP and eligible to receive your full benefit.
How does the Social Security COLA affect my claiming strategy?
The COLA should have little to no impact on your claiming strategy. Because your benefits are automatically adjusted to keep up with inflation, there’s no reason to claim benefits early to receive the increase. If you’re already receiving benefits, COLA will be applied to your 2023 benefits beginning in January.
How does my Social Security claiming strategy fit into my financial goals?
When you delay receiving Social Security benefits past your FRA, those benefits grow by 8% annually until age 70, when your maximum benefit amount is reached. On the flip side, if you begin taking benefits before your FRA, those benefits are reduced. This reduction can be up to 30% if you decide to begin filing at age 62. The increase from delayed credits, as well as the decrease from early filing, is after the COLA, which was first applied to your PIA.3
The decision of when to begin taking Social Security benefits can have a lasting impact on both you and your family, and the annual COLA should not be part of your decision-making process. Instead, your strategy should be based on your personal financial goals, life expectancy, retirement savings, other sources of retirement income and tax liability.
For example, if you’re considering implementing a series of Roth conversions during the period from retirement until age 72, when your required minimum distributions (RMDs) kick in, Social Security can have an impact. Because up to 85% of Social Security benefits are subject to federal tax (and potentially state tax), claiming benefits too early can increase your adjusted gross income and make Roth conversions a less attractive strategy.
How do I develop a Social Security strategy as an U.S. expat?
Because each individual’s financial situation is unique, developing an effective Social Security strategy can be a multifaceted and complex decision. Instead of letting COLA announcements impact your decision, it’s important to work with a qualified wealth manager to establish a strategy that makes sense, given your particular financial situation.
(SIDE NOTE: Some Social Security beneficiaries received more good news related to Medicare Part B premiums, which are set to fall by an average of 3.1% in 2023.4 This news comes as spending on new drugs and other care was lower than expected in 2022. Along with the 2023 COLA, this decrease in healthcare costs should provide some much-needed financial relief to seniors.)
Need some help navigating your Social Security benefits as an expat living overseas? Creative Planning International is here for you. We work with expats and cross-border families to help maximize their wealth and avoid costly mistakes. We understand the complex interaction of multi-jurisdiction tax and regulatory regimes and take into account currency, diversification and other portfolio considerations as we help implement custom retirement and tax planning strategies to meet your specific needs.
To learn more, request a meeting with a member of our team.
