Whether you're already retired or planning to retire at some point in the future, surveys conclusively show that there's a good chance you'll lean on Social Security income in some capacity to make ends meet.
Back in April, national pollster Gallup asked nonretirees to what extent they expect to rely on Social Security income during retirement. A record-high 38% proclaimed it would be a "major source," with another 47% expecting it to be a "minor source" of income. As for retirees, Social Security is a major income source for 57% of respondents and a minor source for an additional 32% of those surveyed.
This reliance on Social Security is precisely why the annual cost-of-living adjustment (COLA) announcement during the second week of October is so closely monitored.
What is the cost-of-living adjustment?
Think of COLA as the "raise" that Social Security's more than 65 million beneficiaries will receive in the upcoming year. You'll note I've put "raise" in quotations, which is to signify that this monthly hike to benefits isn't to help recipients get ahead. Rather, it's to true-up payouts to account for inflation (i.e., the rising price of goods and services) over the past year.
Since 1975, Social Security's COLA has been tethered to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W has eight major spending categories and dozens of subcategories, each with their own respective weighting. By examining year-over-year price changes, the CPI-W can be whittled down to a single number that offers a broad-based look at inflation (or deflation).
However, Social Security's COLA is only determined by CPI-W readings from the third quarter (July through September). The average CPI-W reading from the third quarter (Q3) of the current year is compared to the average CPI-W reading from Q3 of the previous year. If it rises from the previous year, the program's beneficiaries receive a payout boost that's commensurate with the year-over-year percentage increase.
Here's how much the average Social Security benefit will rise next year
On Wednesday, Oct. 13, the last puzzle piece needed to calculate Social Security's COLA for 2022 was released by the Bureau of Labor Statistics. The end result was a 5.9% COLA, which'll represent the largest payout bump for beneficiaries since 1983.
Why such a large benefit increase? The primary culprit was rapidly rising energy prices in the third quarter from the prior-year period. With crude oil and natural gas hitting multiyear highs, the price for all things energy has been soaring. To boot, food, shelter, and medical care inflation have ticked notably higher.
But the more interesting question just might be, "What does a 5.9% COLA actually mean for the average Social Security beneficiary?" Let's take a closer look.
By December, the Social Security Administration (SSA) estimates that the average retired worker will be bringing home $1,565. As a reminder, 47 million of the program's 65 million recipients are retired workers. A 5.9% COLA come January will add $92 to the average retired workers' payout, pushing it to $1,657 a month. For the average retired worker, we're talking about more than $1,100 in added income in 2022.
Social Security also provides a monthly benefit to a shade over 8 million disabled workers. By December, the SSA estimates the average disabled worker will be receiving $1,282. A 5.9% COLA atop this figure works out to an extra $76 a month, or $1,358 for the average disabled worker in January.
The program's 5.8 million survivor beneficiaries should see a sizable nominal boost, too. Extrapolating out the August 2021 payout snapshot from the SSA, I estimate the average survivor benefit will be $1,253 by December. A 5.9% COLA will add $74 a month to what the average survivor of a deceased worker is bringing home monthly, come January.
Social Security's record COLA isn't as impressive as you think
While the program's 65 million beneficiaries will undoubtedly welcome the biggest year-over-year payout increase in nearly four decades, there are two unsettling aspects about this benefit hike that have to be addressed.
First of all, a historic COLA means the programs' beneficiaries are contending with high levels of inflation. Rising shelter and medical expenses, including costlier Medicare Part B premiums, will significantly eat into the added income many beneficiaries expect to receive in 2022. According to a Medicare Trustees report in August, Part B monthly premiums could rise $10 in 2022 to $158.50. This might not sound like much, but for low-income retired workers who Social Security was designed to protect, it could mean a complete or near-complete offset of their "raise."
The second and bigger issue for Social Security recipients is that COLA has done a poor job of reflecting the inflation they're facing. That's because the CPI-W, as its full name implies, tracks the spending habits of urban and clerical workers. Urban and clerical workers are often of working age and rarely receive Social Security benefits. They also spend their money very differently than the senior citizens who comprise the bulk of Social Security recipients.
In other words, the CPI-W tends to underweight highly important expenses for seniors, such as shelter and medical care costs, while overweighting less-important costs, such as apparel and transportation.
The end result is that the purchasing power of Social Security income has declined by 32% since 2000, according to The Senior Citizens League. One year of an above-average COLA doesn't change the fact that seniors can't afford as much as they once could with a Social Security dollar.