When working Americans retire, there's a really good chance that they're going to be reliant on Social Security income to some degree.
In April, national pollster Gallup asked a group of nonretirees to what extent they expect to rely on Social Security income when they hang up their work gloves. An all-time record 38% expect it to be a "major source," with 85% of respondents expected to lean on the program in some capacity to make ends meet.
With this program playing a clear role in the financial well-being of our nation's elderly and disabled people, there's no announcement that's more important than the annual cost-of-living adjustment (COLA), which is released in the second week of October.
What is the cost-of-living adjustment and how is it calculated?
Think of COLA as the "raise" that Social Security's more than 65 million beneficiaries receive nearly every year. I have "raise" in quotation marks because it's not extra money designed to help the program's recipients get ahead. Rather, it's a boost aimed at trueing-up payouts to match the inflation beneficiaries have contended with over the past year. As the prices for goods and services go up, the benefits paid to retired workers, long-term disabled people, and survivors of deceased workers should rise, too.
Since 1975, Social Security's COLA has been tethered to the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W (thank goodness for acronyms). This index tracks a predetermined basket of goods and services. It has eight major spending categories, with dozens upon dozens of subcategories, and each category has its own relative weighting. Ultimately, the CPI-W can be boiled down to a neat and tidy single number that can be compared to the previous year's reading to determine if prices are rising (inflation) or falling (deflation).
In the case of Social Security, only the CPI-W readings from the third quarter (Q3), July through September, are used to determine the following year's COLA. While the other nine months can help identify trends, they have no bearing on the announced COLA. If the average CPI-W reading from Q3 in the current year is higher than the average CPI-W reading from Q3 of the previous year, beneficiaries will receive a raise commensurate with the percentage increase, rounded to the nearest tenth of a percent.
The hard truth about Social Security's mammoth upcoming "raise"
For 2022, nearly all current Social Security beneficiaries will be looking at their largest benefit increase in history. Based on CPI-W data for July and August, The Senior Citizens League (TSCL), a nonpartisan advocacy group for seniors, predicts COLA for the upcoming year will likely come in at 6%. This means monthly benefits would rise by 6% come January 2022.
For the average retired worker, who's expected to be receiving $1,568 a month by December, a 6% COLA would translate to a $94 monthly bump-up in payout. The last time Social Security recipients saw a COLA of 6% or higher was all the way back in 1983, when the COLA passed along for that year was 7.4%. Unless you were netting a payout from Social Security 39 years ago, this should be the biggest raise ever for its 65 million-plus recipients.
But there's a catch.
The grim reality is that most of the program's recipients aren't going to see much or any of this increase, as higher prices for a variety of goods and services eat up their payout boost.
For example, the Congressional Research Service estimates Medicare Part B monthly premiums will rise from $148.50 in 2021 to $157.70 per month in 2022. This equates to a 6.2% increase, which is even higher than the predicted COLA by TSCL. Between 2000 and 2020, the average annual Medicare Part B premium hike has been 5.9%, compared to an average Social Security COLA of 2.2% over the same time frame. And that's not all.
According to Bureau of Labor Statistics (BLS) inflation data from August, a number of other key categories in the Consumer Price Index for all Urban Consumers (CPI-U) show signs of higher inflation. The CPI-U is a similar financial measure to the CPI-W. In August, the CPI-U showed shelter inflation up 2.8% over the trailing 12 months, food inflation up 3.7%, and electricity up 5.2%. While used car inflation may not be affecting Social Security's retired workers, they all need a roof over their heads, food on their tables, and electricity in their homes.
These figures suggest a lot of recipients will see most or all of their payout boost in 2022 disappear.
But wait -- there's more
The truly sad thing for the program's recipients is that this disparity has been going on for more than two decades. According to a report from TSCL, the purchasing power of Social Security income has declined by 30% since 2000. In other words, what $100 in Social Security benefits could buy in 2000 can now only purchase about $70 worth of those same goods and services.
The reason this disparity exists is simple: The CPI-W is doing a terrible job of measuring inflation for the program's recipients.
As its name alludes, the CPI-W is tasked with tracking the expenditures of urban and clerical workers. These are usually working-age Americans who are rarely receiving Social Security benefits. That's a problem, because urban and clerical workers spend their money very differently than the senior citizens who account for the vast majority of Social Security's monthly recipients.
For instance, two of the most important spending categories for retired workers are housing and medical care. A December 2011 comparison between the CPI-W and CPI-U by the BLS showed that the CPI-W pretty substantially underweights shelter and medical care costs in its formula. Meanwhile, less meaningful expenses to seniors, such as transportation, apparel, and education, are given added weight in the index.
The kicker here is that lawmakers from both sides of the political aisle on Capitol Hill agree that the CPI-W is doing a poor job of reflecting the true inflation that seniors are contending with. Unfortunately, those parties are miles apart in coming up with a solution. This means the purchasing power of Social Security income is liable to keep declining over time.