A $10,000 Social Security hit
The government won't give cost of living increases next year, eroding the effect of compound interest.
By Joe Mont, TheStreet.com
Americans, who lost a combined $1 trillion in 401k retirement plans during the stock market crash, could each lose another $10,000 in Social Security benefits as the government fails to give cost of living increases for the first time in 35 years.
The Social Security Administration this month announced that seniors won't receive an annual cost of living adjustment, which is linked to inflation, in their checks next year. The Congressional Budget Office is forecasting no increase in 2011 either. It's the first time since 1975 that the benefits won't be tied to the consumer price index.
The move has been justified because consumer prices declined 2.1% during the economic recession of the past year. President Barack Obama has proposed giving Social Security recipients a one-time payment of $250 to cushion the blow.
Compound interest acts as a snowball effect for retirement accounts. It adds a small percentage to principal and layers future interest on top of the total, repeating the process through the term of the investment. To put it in perspective, a $1,000 investment earning 10% in compound interest a year would grow to almost $45,000 after 40 years.
But this multiplying effect also means that even a slight reduction to either the principal or interest rate looms large over the years. For the average beneficiary receiving $1,161 a month, it means losing an additional $35 a month. According to an analysis by the Senior Citizens League (SCL), an advocacy group with 1.2 million members, the 2010 freeze will reduce benefits by $10,134 during the course of a 20-year retirement. If there's no increase in 2011, the loss would jump to $20,144.
The SCL study says the decrease in benefits will hit seniors hard because they've already lost significant buying power since 2000. Medicare Part B premiums have more than doubled since then, heating oil has risen 96% and the price of a dozen eggs is up 99%. According to the group, 70% of beneficiaries depend on Social Security for at least half of their income. It's the sole source of income for 15%.
"Although President Obama's call for a payment of $250 will help seniors, it is a distraction, since the zero cost of living allowance will cost retirees thousands in lost compounding throughout their retirement," says Shannon Benton, executive director of the SCL. "Today, a senior can buy just 80% of what they could have afforded at the beginning of the decade."
The group is supporting proposed legislative efforts that would restore a 3% percentage increase to benefits.
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