Social Security benefits increase periodically due to Cost of Living Adjustments (COLAs). COLAs are built into the program to help ensure benefits don't lose buying power as prices rise.
In 2022, retirees are on track to get a huge COLA -- the largest one since 2009. But while this sounds like good news, seniors may not necessarily end up financially better off with the bigger benefit check.
Seniors are on track for bigger checks -- but not more buying power
While Social Security retirees may get a lot more money next year, the sad reality is that the benefits increase may not actually give them any more buying power. In fact, many seniors could actually end up in a much worse financial position next year.
To understand why that's the case, it's helpful to know how COLAs are calculated. The benefits increase doesn't just come out of thin air -- it's based on changes to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).
The average CPI-W for the months of July, August, and September is compared to the average for these same months in the prior year to assess how large a COLA seniors are entitled to.
While we don't have this data yet, the CPI increase over the past 12 months has come in around 5%. And unless things drastically change, current levels of inflation suggest seniors could be on track for around a 4% COLA in 2022.That's the highest since 2009, when seniors saw a 5.8% benefits increase.
Here's why a large COLA can be very bad news
Unfortunately, the reason seniors are in for such a high raise is because prices have been rising in key areas including furnishings, automobiles, clothing, and airline tickets.
With the cost of goods and services going up, seniors will likely find their bigger benefits don't actually allow them to buy more than they currently can afford. Sadly, next year's high COLA may not even be sufficient to maintain current spending levels, much less increase spending despite the larger checks.
That's the case for two reasons. First, rising Medicare premiums could reduce the value of the COLA. And second, CPI-W is actually an inadequate measure of inflation that retirees experience because it underweights key expenses such as housing and healthcare.
CPI-W is such a poor reflection of seniors' spending habits that benefits have actually lost about 30% of buying power since 2000. And despite the likelihood of a large benefits increase, things could get worse in 2021 since the very expenses that are undercounted -- medical expenses and housing costs -- have both increased dramatically recently.
As if that isn't bad enough, most seniors rely on Social Security and savings to help them cover routine costs. And the same inflationary pressure enabling retirees to earn a large COLA will also reduce the effective value of the money in their savings accounts.
So while retirees may be excited about the prospect of getting a 4% Social Security raise next year, the conditions causing it very likely could leave them worse in the end.
The one bright spot, however, is that seniors who realize that a large raise isn't necessarily good news can start preparing now to cope with the effects of rampant inflation. That may mean making adjustments to your budget, or even looking for additional income sources such as part-time work. By preparing now, retirees can help protect their finances even if the largest COLA in a decade does little to shield them from the effects of inflation.