Whether you’re currently retired or just entering the workforce, chances are that America’s most successful social program, Social Security, plays a key role in your financial well-being.
According to surveys conducted by national pollster Gallup in April 2021, 85% of non-retirees expect to depend on their Social Security income to some degree to make ends meet in retirement. This compares somewhat similarly to the 89% of retirees surveyed who already relied on Social Security as a “major” or “minor” source of income.
Because of the critical role that Social Security will/plays for most workers during retirement, arguably no announcement from the Social Security Administration is watched more closely than the annual cost of living adjustment. (COLA).
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What is the Social Security cost of living adjustment and how is it calculated?
Simply put, COLA is the “increase” beneficiaries receive in most years to account for inflation. If the price of goods and services increases compared to the previous year, recipients should receive a proportional increase in benefits so that they can still afford the same amount of goods and services.
You will also notice that I put “increase” in quotation marks to indicate that it is not an increase in the truest sense of the word. Instead, COLA is simply designed to equalize benefits to match the prevailing rate of inflation (not to help recipients get ahead).
Since 1975, the consumer price index for urban wage and office workers (CPI-W) has been the inflationary thread running through the program. To determine the Social Security COLA for the coming year, only the CPI-W readings from the third quarter (July through September) are used. The other nine months can be useful for identifying trends, but they will not be factored into the Social Security COLA calculation.
If the average CPI-W reading for the third quarter of the current year is higher than the average CPI-W reading for the third quarter of the previous year, beneficiaries are in line for an “increase” . The amount of increase is the year-over-year percentage increase in the average CPI-W reading for the third quarter, rounded to the nearest tenth of a percent.
It all sounds very simple, but things have gone wrong.
Social Security recipients have lost 40% of their purchasing power since 2000
Although there is a clear formula for passing on inflationary increases in benefits, Social Security’s COLA has done poorly in keeping up with the inflation that the average Social Security recipient has faced since the turn of the century.
According to a new report by nonpartisan senior citizen advocacy group The Senior Citizens League (TSCL), the purchasing power of Social Security dollars has shrunk 40% since 2000, as of March 2022.
For more context, the loss of purchasing power of 10 percentage points over the last 12-month period (March 2021 to March 2022) is the largest ever recorded by Mary Johnson, Social Security policy analyst for TSCL. Johnson pointed to a number of rapidly rising costs over the past year that have led to this loss of purchasing power, including a 79% increase in heating oil expenses, as well as some insurance premiums- sickness and healthcare costs that are not part of the Social Security COLA calculation.
Since 2000, the overall increase in monthly benefits via COLAs is 64%. This means the average monthly benefit has risen from $816 in 2000 to $1,336.90 by 2022. However, Johnson’s study found that a 130% increase in payments was needed simply to keep up with spending typical of the elderly. A COLA of 130% since 2000 is equivalent to a monthly benefit of $1,876.70. This monthly shortfall of $539.80 equates to almost $6,500 in lost annual purchasing power for the average beneficiary over 22 years.
COLA calculation is flawed and there is no easy fix
If you wonder how it is possible that Social Security is failing tens of millions of elderly people so badly, look no further than its inflationary nexus, the CPI-W.
As its official name suggests, the CPI-W measures the spending habits of urban and office workers. The problem is that urban and office workers spend their money very differently from older people. For example, a much higher percentage of seniors’ monthly expenses go toward housing and medical costs, compared to working-age Americans. In comparison, the latter spend much more on education, clothing and transport than seniors. Because the CPI-W is the nexus of Social Security, significant costs for the elderly are not sufficiently weighted, resulting in a persistent loss of purchasing power for more than two decades.
Interestingly, lawmakers from both major political parties recognize that the CPI-W does a poor job of accurately tracking inflation. However, lawmakers have approached solving the problem from opposite ends of the political spectrum and have so far been unwilling to give an inch to find common ground with their opposition.
Until there is a compromise at the congressional level, Social Security will be stuck with CPI-W as its inflationary tether, and recipients will continue to see the purchasing power of their monthly benefits erode at the over time.
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