Whether or not you realize it, you're likely going to be reliant, at least to some degree, on Social Security income when you retire.
Last month, national pollster Gallup surveyed currently retired workers and nonretirees to get a sense of how important Social Security income is, or is expected to be, in their golden years. According to the results, 89% of current retirees lean on their Social Security income to some varying degree to make ends meet, while a combined 84% of nonretirees anticipate it'll be a "major" or "minor" source of income during retirement.
![A senior holding an assorted, fanned pile of cash bills in their hands.](https://g.foolcdn.com/image/?url=https%3A%2F%2Fg.foolcdn.com%2Feditorial%2Fimages%2F682042%2Fsenior-man-counting-cash-money-bills-social-security-retire-invest-inflation-cola-getty.jpg&op=resize&w=700)
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Considering how important Social Security is to the financial well-being of tens of millions of retired beneficiaries, it's perhaps no surprise that the annual cost-of-living adjustment (COLA) is the most-anticipated announcement of the entire year.
What is Social Security's cost-of-living adjustment (COLA)?
Think of Social Security's COLA as a "raise," but not a traditional one designed to help folks get ahead. Rather, Social Security's COLA is a way to ensure that the program's beneficiaries are being given a payout boost to keep up with the rising price of goods and services (i.e., inflation).
Prior to 1975, these benefit hikes were arbitrarily handed out by special sessions of Congress. Since then, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has served as the program's inflationary tether. The CPI-W has eight major spending categories, as well as dozens upon dozens of subcategories, each of which have their own percentage weightings. These weightings are what allows us to neatly and concisely describe whether prices are rising or falling with a single CPI-W reading.
Interestingly, Social Security's COLA is only determined by the CPI-W readings from the third quarter (July through September). Even though CPI-W readings from the other nine months aren't used in the COLA calculation, they can still be useful in identifying inflationary or deflationary trends.
Without getting overly complicated, if the average CPI-W reading from the third quarter (Q3) of the current year is higher than the average CPI-W reading from Q3 of the previous year, inflation has occurred and beneficiaries will receive a "raise." The amount of the benefit hike is simply the year-over-year percentage increase in the average CPI-W readings, rounded to the nearest tenth of a percent. Pretty straightforward.
![A Social Security card wedged between a fanned stack of cash bills.](https://g.foolcdn.com/image/?url=https%3A%2F%2Fg.foolcdn.com%2Feditorial%2Fimages%2F682042%2Fsocial-security-card-with-cash-retirement-benefits-getty.jpg&op=resize&w=700)
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Who's ready for the biggest nominal-dollar benefit increase in history?
What isn't straightforward is what's happening on the inflation front right now. In April, the U.S. Bureau of Labor Statistics reported that the trailing-12-month inflation rate hit 8.3%. This was actually down from the 8.5% inflation rate reported in March, which marked a 40-year high.
If you're wondering why inflation is soaring, the answer lies with a couple of factors. To begin with, the nation's central bank left its foot on the accelerator for too long, resulting in historically low interest rates and a bond-buying program (known as quantitative easing) that was designed to weigh down long-term Treasury bond yields to encourage lending.
We've also witnessed commodity prices soar in the wake of the COVID-19 pandemic and following the invasion of Ukraine by Russia. Supply chains are broken in many industries around the world, and there's no immediate supply relief in sight for crude oil or natural gas.
For Social Security beneficiaries, it means one thing: A mammoth monthly benefit increase is on the horizon.
According to a recently released report from nonpartisan senior advocacy group, The Senior Citizens League (TSCL), COLA for the upcoming year could hit 8.6%. On a percentage basis, it would be the largest year-over-year benefit increase in 41 years. But on a nominal-dollar basis, it would represent the largest "raise" ever.
As of April 2022, the average retired worker was taking home $1,666.49 per month. By the end of the year, I estimate this average payout, which grows by approximately $2 each month as new retirees enter the benefit pool, will rise to approximately $1,683. An 8.6% COLA on this amount would result in about a $145 per-month increase in retired-worker benefits to $1,828 by January 2023.
![Scissors cutting a one hundred dollar bill in half.](https://g.foolcdn.com/image/?url=https%3A%2F%2Fg.foolcdn.com%2Feditorial%2Fimages%2F682042%2Fcut-spending-scissors-cash-budget-getty.jpg&op=resize&w=700)
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A Social Security dollar isn't what it used to be
On the surface, an average benefit increase of $145 per month for retired beneficiaries would probably have folks excited. But the unfortunate truth is that the inflation seniors are facing has vastly outpaced the COLAs they've received for the past 22 years.
Mary Johnson, a Social Security policy analyst for TSCL, compared the cumulative COLAs seniors have been given since 2000 to the COLAs that would have been necessary to keep pace with inflation since the start of the century. Whereas COLAs have cumulatively risen 64% since 2000, typical senior expenses have grown by 130%. Based on the average monthly Social Security benefit of $816 per month in 2000, today's seniors have been shortchanged by almost $540 a month over the past 22 years. That's close to $6,500 a year in lost purchasing power.
The purchasing power of Social Security income has plunged 40% since the beginning of the century for one key reason: The CPI-W does a poor job of accounting for the inflation retired workers are contending with.
As its full-name implies, it's an index catered to urban wage and clerical workers. These are typically working-age Americans who spend their money differently than senior citizens. As a result, the CPI-W has a tendency to underweight critical spending categories for aged Americans, such as medical care and housing, while giving added credence to lesser-important expenses, such as transportation, education, and apparel.
The real kick in the pants is that lawmakers on Capitol Hill are in agreement that the CPI-W is flawed -- they just can't agree how to fix it. Democrats and Republicans both have proposals they believe would be an improvement, but neither party has been willing to cede an inch to find common ground with their opponent.
Even with the largest nominal-dollar benefit increase in history likely on tap for 2023, retired workers, unfortunately, have little to celebrate.