Inflation and Social Security Updates for U.S. Taxpayers Living Abroad

Without regard to one’s location, it is generally acknowledged that the United States’ inflation rate is the highest it has been for decades. The tumultuous nature of global stock and bond markets has led many individuals to question the future economic prospects. Despite the economic uncertainty, there is some reason for optimism because Social Security beneficiaries will receive the greatest cost-of-living adjustment (COLA) in over 40 years in 2023, which is 8.7%. For American expats who either now receive Social Security benefits or are nearing eligibility, this significant rise in benefits is particularly favorable.

In this piece, we address frequently asked queries concerning the Social Security Administration’s COLA calculation process as well as potential effects the adjustment may have on your benefits and claiming approach.

How is the Social Security COLA determined?

The Consumer Price Index for Urban Wage Earners and Clerical Workers, which is a component of the Consumer Price Index (CPI), serves as the foundation for the COLA (CPI-W). The difference between the CPI-average W’s price in the third quarter of the current year and its average price in the third quarter of the previous year is how the Social Security Administration determines the COLA. The benefits for the following year are then increased by the specified percentage. A 0% COLA is applied to the benefits for the following year if the variation in the average CPI-W from one year to the next is 0% or less (the last year of 0% COLA was in 2016).

How will the COLA affect my Social Security benefits?

Starting in January, if you currently receive Social Security payments, the COLA is automatically added to your current-year benefits. If your benefit amount was $2,500 per month in 2022, for instance, it will rise to $2,717.50 ($2,500 x 1.087)per month in January 2023.

You will be qualified for the COLA if you have attained the age of 62 but have not yet applied for Social Security; nevertheless, the computation process is slightly different. The primary insurance amount (PIA), or benefit amount you would be qualified to receive at full retirement age (FRA), is subject to the COLA. Then, using your current, COLA-adjusted PIA, your Social Security benefit projections at various claiming ages are generated.

It is also crucial to be aware that your Social Security PIA is determined by taking the top 35 years of earnings into account. Additionally, such earnings are inflation-indexed. In order to account for changes in average national incomes and standards of living over time, future Social Security recipients who have not yet reached age 62 will see their prior earnings adjusted.

What is the effect of my foreign pension on the Social Security COLA?

The Windfall Elimination Provision (WEP) may apply to you if you are eligible for both Social Security retirement benefits and a retirement pension from an employment where you did not contribute to Social Security. Many overseas pensions fall into this category and would be regarded “non-covered” under this provision. On the basis of your years of significant Social Security earnings, WEP often lowers your PIA. Additionally, if your spouse applies for spousal Social Security benefits, which can equal up to 50% of the primary worker’s benefit, they will be based on your benefit once WEP has been taken into account.

The excellent thing is that you are still qualified to receive Social Security COLAs regardless if you are subject to WEP. Furthermore, WEP does not affect survivor benefits, which would be taken away from your spouse or other family members in the event that you passed away. Lastly, you are exempt from WEP and qualified to collect your full benefit if you have 30 or more years of significant Social Security earnings.

How does the Social Security COLA impact my claiming strategy?

Your claiming strategy should not be significantly impacted by the COLA. There is no need to file for benefits early in order to get the raise because they are automatically increased to keep up with inflation. If you are already receiving benefits, the COLA will be incorporated starting in January 2023 into your benefits.

How does my Social Security claiming strategy fit with regards to my financial objectives?

Delaying the receiving of Social Security payments past the full retirement age (FRA) results in annual increases of 8% in benefits up until the age of 70, at which point the maximum benefit amount is attained. Contrarily, choosing to start receiving benefits before achieving the FRA will lead to a decrease in benefits, with a possible reduction of up to 30% if benefits start before age 62. It should be noted that the effects of these adjustments—both the gain from delayed credits and the decrease from early filing—are applied following the application of the cost-of-living adjustment (COLA) to the primary insurance amount (PIA).

The annual COLA shouldn’t factor into your decision-making process because the timing of when you start receiving Social Security payments might have a long-lasting effect on you and your family. As an alternative, your plan should be determined by your own financial objectives, life expectancy, retirement savings, other sources of retirement income, and tax liability.

The potential impact of Social Security should be considered when planning to undertake a series of Roth conversions between retirement and the age of 72, when the requirement for minimum distributions (RMDs) takes effect. It should be remembered that state tax and federal tax may apply to up to 85% of Social Security income. As a result, prematurely claiming benefits can increase your adjusted gross income and make it less appealing to use Roth conversions as a viable strategy.

How can I establish a Social Security plan as an American taxpayer living abroad?

Due to the distinctiveness of each person’s financial situation, creating an effective Social Security strategy can be a difficult and varied decision. It is advised that you avoid letting the announcements of Cost-of-Living Adjustments (COLA) affect your choices. To develop a strategy that fits your unique financial position, it is essential to work with a certified wealth manager.