Regardless of whether you're just entering the workforce or already retired, Social Security is likely to play a key role in helping you make ends meet during your golden years.
According to a 2022 survey by national pollster Gallup, 89% of current retirees lean on their monthly Social Security payout as a "major" or "minor" source of income. Meanwhile, 85% of non-retirees anticipate relying on Social Security income to some degree after they hang up their work coats for good. Both of these figures are near all-time highs.
Given the critical role Social Security plays for tens of millions of mostly retired Americans, it should come as no surprise that the program's cost-of-living adjustment (COLA) is the most-anticipated announcement each year.
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What is Social Security's cost-of-living adjustment and how is it calculated?
In simple terms, COLA is the "raise" that beneficiaries receive nearly every year. You'll note that I have "raise" in quotation marks, which is to represent that this isn't a raise in the true sense of the word. The purpose of Social Security's COLA is to account for the inflation that program recipients have contended with over the past year. If the prices for goods and services increase, benefits should ideally rise in step to match those increases. Thus, COLA is more about keeping Social Security recipients on par with inflation, even though it's a nominal increase (i.e., "raise") in their monthly payout.
Prior to 1975, Social Security's COLAs were arbitrarily approved by special sessions of Congress. But since then, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has served as the program's annual inflationary tether.
The CPI-W has eight major spending categories and dozens upon dozens of subcategories, all with their own individual weightings. These weightings allow us to take a large predetermined basket of goods and services and break it down to a single CPI-W reading that helps us easily understand what's going on with prices (i.e., whether inflation or deflation is occurring).
The interesting thing is that only readings from the third quarter (July through September) factor into Social Security's COLA calculation for the upcoming year. While CPI-W readings from the other nine months can be useful for identifying trends, they won't have any effect on Social Security's COLA.
Once you have the third-quarter (Q3) CPI-W readings from the U.S. Bureau of Labor Statistics (BLS), calculating Social Security's COLA for the upcoming year is straightforward. If the average Q3 CPI-W reading in the current year is higher than the average Q3 CPI-W reading in the previous year, inflation has occurred and beneficiaries are getting a "raise." The amount of the "raise" is commensurate with the year-over-year percentage increase, rounded to the nearest tenth of a percent.
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Who's ready for the biggest benefit jump since 1982?
For much of the past 12 years, Social Security's COLAs have been small or nonexistent. In 2009, 2010, and 2015, the CPI-W declined on a year-over-year basis, resulting in no COLA being passed along to beneficiaries the following years (2010, 2011, and 2016). But 2023 could bring about a benefit increase not seen in multiple generations.
Recently, The Senior Citizens League (TSCL), a nonpartisan senior advocacy group, suggested that the COLA for 2023 could be as high as 7.6%. If accurate, this would be the biggest year-over-year increase in Social Security benefits since 1982 (11.4%), and it would mark the fifth-largest COLA since the CPI-W became the annual inflationary tether in the mid-1970s.
What would a 7.6% COLA mean for the average retired worker? By December, I estimate the average retired beneficiary will be taking home about $1,636 a month. A 7.6% benefit boost come January 2023 would equate to an extra $124 a month or nearly $1,500 more for the full year.
The reason for this estimated historic jump in Social Security benefits is simple: Inflation is soaring. In February, the BLS reported a 7.9% year-over-year increase in the Consumer Price Index for All Urban Consumers (CPI-U), which marked a 40-year high. The CPI-U is a similar measure of inflation to the CPI-W.
The prices for every major spending category of the CPI-U have risen over the trailing-12-month period, through February 2022. Gasoline prices are up 38%; new and used vehicle prices have soared 12.4% and 41.2%, respectively; and with home prices jumping, shelter costs are up 4.7% from the previous year. Shelter is the largest weighted item in the CPI-U.
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This looks like a no-win scenario for Social Security beneficiaries
Superficially, a close to $125 a month increase in Social Security benefits for 2023 probably sounds great. But not all is what it seems.
As noted, Social Security's COLA isn't about helping beneficiaries get ahead. It's simply a tool that's designed to keep program recipients on par with inflation. The biggest payout bump in 41 years sounds fantastic until you realize that most or all of this increase is likely to be eaten up by inflation that's also hitting 40-year highs.
To make matters worse, the purchasing power of Social Security dollars has been steadily declining since the start of the century. Based on a report from TSCL, Social Security benefits have lost 32% of their buying power since 2000. In other words, what $100 in benefits could buy in 2000 will now only buy about $68 worth of those same goods and services. Not even a 7.6% COLA in 2023 can swing this pendulum back in favor of beneficiaries.
The real issue for Social Security is that the CPI-W doesn't do a good job of measuring inflation for a majority of the program's recipients.
As its full name implies, the CPI-W tracks the spending habits of urban and clerical workers. These are people who are typically of working age, and they spend their money very differently from the seniors who comprise the majority of Social Security's beneficiaries. As a result, the CPI-W has a tendency to underweight important costs to seniors, such as shelter and medical care, while giving added weighting to less important spending categories, such as education, apparel, and transportation.
Interestingly, even lawmakers in Congress recognize that the CPI-W is doing seniors a disservice as Social Security's inflationary tether. Unfortunately, since America's two major political parties are approaching a fix from opposite ends of the spectrum and neither side is willing to cede an inch to find common ground, there's no fix for this dilemma on the horizon.
Long story short, no matter how large of a COLA beneficiaries are in line to receive in 2023, the purchasing power of Social Security income is expected to keep declining over time.
