Social Security is our nation's most important social program. According to a report from the Center on Budget and Policy Priorities in February 2020, Social Security is responsible for pulling 21.7 million Americans out of poverty each year, including 14.8 million retired workers.
What's more, a vast majority of current and future retirees currently lean on, or expect to lean on, Social Security income to make ends meet. In 2021, when national pollster Gallup questioned respondents about their reliance on Social Security payouts, 89% of current retirees described it as a "major" or "minor" income source, whereas an all-time high 85% of nonretirees expected to lean on the program in some capacity during retirement.
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All eyes are on Social Security's cost-of-living adjustment
Given the importance placed on Social Security payouts, there's no announcement that's more anticipated each year than the cost-of-living adjustment, or COLA.
In easy-to-understand terms, COLA represents the annual payout increase passed along to the programs' more than 65 million beneficiaries that's designed to keep them on par with inflation (i.e., the rising price of goods and services). If the price for a basket of goods and services increases, Social Security benefits should increase in unison so retirees can continue to afford those same goods.
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been the inflationary tether for the Social Security program. Specifically, only readings from the third quarter (July through September) are used to determine the upcoming years' COLA. If the average third-quarter CPI-W reading in the current year is higher than the average third-quarter CPI-W reading from the previous year, beneficiaries will receive a "raise" in the upcoming year that's commensurate with the percentage increase, rounded to the nearest tenth of a percent.
Note that I've put "raise" in quotation marks to represent that COLA is designed to keep beneficiaries on pace with inflation, not to help them get ahead. In other words, COLA isn't a raise in the true sense of the word.
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Despite a huge COLA in 2022, retired workers keep losing out
With inflation soaring in the back half of 2021, Social Security beneficiaries are basking in their biggest payout hike in nearly four decades -- a 5.9% COLA. For the average retired worker, this equates to about $92 more each month, or in excess of $1,100 in added benefits this year.
Unfortunately, this well-above-average 2021 COLA, and the many COLAs that preceded it since the turn of the century, aren't coming close to keeping pace with the actual inflation seniors are contending with.
In October, The Senior Citizens League (TSCL), a nonpartisan senior advocacy group, compared the impact of Social Security's COLAs since 2000 to the real inflation retired workers have faced. The aggregate increase in COLA since the turn of the century (and prior to the 5.9% COLA announcement) amounted to 55%. This means the average Social Security benefit has grown from $816 a month to about $1,262 a month in 2021.
However, the typical expenses seniors have faced over this same 21-year period have risen by a considerably faster 104.8%. In order for Social Security benefits to have kept pace with inflation, retired workers should have been receiving $1,671 a month in 2021, or about $409 more per month, according to TSCL. When extrapolated over a year, we're talking about a shortfall of approximately $4,900 for the average Social Security beneficiary.
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Here's why Social Security beneficiaries are getting shortchanged by COLA
How does the purchasing power of Social Security income decline by 32% in just 21 years for retired workers? The answer is simple: The CPI-W does a poor job of accurately tracking the inflationary pressures seniors are contending with.
The full name of the CPI-W -- Consumer Price Index for Urban Wage Earners and Clerical Workers -- offers a huge clue as to why this inflationary tether is failing seniors. Urban wage earners and clerical workers typically aren't seniors, and they're rarely receiving a Social Security benefit. Therefore, the program is effectively tied to the spending habits of working-age Americans.
Herein lies the issue: Working-age people spend their money very differently than retired workers. For retirees, housing costs and medical care will typically account for a larger percentage of total household expenditures than for working-age people. Comparatively, working-age Americans spend more on things like education, entertainment, apparel, and transportation than seniors do. The CPI-W assigns a higher weighting to these lesser-importance categories while underweighting expenses like housing and medical care. The end result is the roughly $4,900 loss of purchasing power for the average Social Security beneficiary over 21 years.
Worst of all, even though lawmakers on Capitol Hill agree that the CPI-W is doing a poor job of tracking inflation for Social Security's 65 million-plus beneficiaries, no changes are expected anytime soon, primarily because Democrats and Republicans can't agree how to fix it. Both parties believe they have the solution that'll work best, and neither is willing to cede an inch or find common ground.
Even with the highest COLA since 1983, beneficiaries should expect their Social Security income to continue losing purchasing power over time.
