2012 Social Security Payments to Rise 3.6%

Program’s first cost of living adjustment in three years reflects rising consumer prices.

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Social Security benefit payments will rise by 3.6 percent in 2012. The increase in the program's annual cost of living adjustment (COLA) will be its first in three years. The increase translates into $42.57 more a month for the average retiree, who is now paid $1,182.40 a month.

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Social Security payments also are linked to Medicare premiums. Next year's COLA will permit the first increase in three years in the Medicare premium paid by existing beneficiaries for Part B services for physicians and other outpatient expenses. The 2012 Part B premium will be announced by the end of the month, according to a spokesperson for the Centers on Medicare & Medicaid Services.

For people still working, the COLA increase will also translate into a higher earnings ceiling for Social Security payroll taxes. The ceiling has remained at $106,800 for three years, but the agency says it will rise in 2012 to $110,100.

The Social Security COLA is based on a version of the U.S. Consumer Price Index tailored for people who work. It's called the CPI for Urban Wage Earners and Clerical Workers, or the CPI-W. Every year, Social Security looks at the CPI-W average during the third quarter of the year, compares it with the average during the previous year's third quarter, and designates any percentage increase as the following year's COLA.

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Following a big surge in oil prices in the summer of 2008, the CPI-W spiked and led to a big 5.8 percent COLA increase for 2009—the program's largest in 25 years. Oil prices later declined and so did overall inflation. In both 2009 and 2010, the third-quarter average for the CPI-W was less than it was during 2008's third quarter. As retirees know all too well, this meant no COLA in 2010 or 2011.

However, oil and other prices have crept up, and the third-quarter average this year for the CPI-W was 223.233 on a seasonally unadjusted basis. This is 3.6 percent higher than the CPI-W average of 215.495 during the third quarter of 2008, thus explaining the 2012 COLA.

The relationship between the COLA and Medicare premiums is complicated. There is a "hold harmless" clause that prohibits Social Security payments from declining from one year to the next. So, the absence of a COLA in 2009 and 2010 meant that there could be no increase in Part B premiums for existing beneficiaries. This premium has thus been frozen at $96.40 a month for about 75 percent of beneficiaries.

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Another provision of the law, however, requires Part B premiums to finance 25 percent of Medicare's total costs of providing covered services. With premiums frozen for most beneficiaries but healthcare costs still rising, Medicare had to look to new and higher-income beneficiaries to pay bigger premiums to maintain that 25 percent finance level.

New enrollees in 2011, for example, have had to pay a monthly Part B premium of $115.40 if they earned less than $85,000 a year ($170,000 for couples). Rates for higher-income earners rise substantially, and the wealthiest beneficiaries pay premiums approaching 80 percent of their costs, not 25 percent.

With the COLA rising in 2012, Medicare will once again be able to raise premiums on existing beneficiaries, and this increase may also take some of the payment pressures off new and high-income beneficiaries.

However, higher Part B premiums could make it more attractive for beneficiaries to seek coverage through a Medicare Advantage (MA) policy. MA policies compete with traditional Medicare. The government has already announced that MA premiums will drop in 2012 by about 4 percent for the average policyholder. The open enrollment period for 2012 Medicare policies began October 15 and extends through December 7.

Twitter: @PhilMoeller