Social Security benefits have been losing buying power for decades, despite cost of living adjustments (COLAs) that are supposed to help them keep pace with inflation.
The most commonly cited reason for this problem is that the wrong financial index is used to set the amount of the raises retirees receive. COLAs are calculated by measuring price changes using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Many experts believe a change should be made to the Consumer Price Index for the Elderly (CPI-E) because CPI-W underweights key areas such as healthcare and housing, which tend to eat up a larger share of retiree income.
However, the Center for Retirement Research at Boston College has now revealed something surprising about the big raise retirees are going to get in 2022. Their data suggests using CPI-W actually left seniors better off this year -- and could do so in the foreseeable future as well. Here's why.
This year's raise shows the current COLA formula could leave retirees in a better position
Conventional wisdom says that a switch to CPI-E would be better for Social Security retirees because the financial index would weigh healthcare and housing costs more heavily and thus better reflect the inflation retirees actually experience over time. And, indeed, a look at the historical data shows CPI-E would have resulted in retirees getting higher raises.
In fact, according to the Center for Retirement Research, the average annual increase in CPI-E between 1983 to 2021 was 2.8%, while the average annual increase in CPI-W was just 2.6%. So retirees lost out on about 0.2% per year over many decades.
However, the gap between the different price indexes has been narrowing. During the first 20 years after CPI-E was created, it rose 0.4 percentage points per year faster than CPI-W. But over the most recent 20 years, there was only a 0.05 percentage point difference between the two indexes.
And in 2021, CPI-E actually showed a slower increase in prices than CPI-W did. So had a change been made to CPI-E, seniors would have ended up with a smaller raise. Specifically, if the proposed shift had occurred, seniors would have received just a 4.8% benefits bump, compared with the 5.9% benefits increase they're actually entitled to next year.
This has happened for a simple reason: The rate of inflation for healthcare costs has slowed down in recent years, while transportation costs have increased at a faster pace. And CPI-W weighs transportation more heavily than healthcare, while CPI-E does the reverse.
Due to the COVID-19 pandemic, many people shied away from doctor and hospital visits. This meant that the rate of medical care inflation was especially low -- which is why CPI-W actually resulted in a larger raise for seniors than CPI-W would have.
The Center for Retirement Research indicates that while this unique 2021 trend isn't likely to occur again, transportation costs may still continue to rise quickly while medical inflation is held in check. And, if that's the case, a switch to CPI-E could end up leaving seniors worse off than sticking with the status quo.