Many investors see inflation as their biggest fear, and soaring prices on essentials like food and fuel have hurt consumers deeply. For those living on a fixed income through Social Security, those price increases are especially difficult to handle.
Fortunately, Social Security recipients get annual increases in their benefits based on inflation. However, there's a lag before the payment boosts kick in. Right now, price trends suggest that even after the 39-year high cost-of-living adjustment (COLA) of 5.9% that Social Security gave last year, the COLA that will take effect at the beginning of 2023 could be far higher.
Accelerating inflation in 2022
As bad as inflation was in 2021, this year's price increases have only accelerated. Coming into last Friday's report on the Consumer Price Index (CPI), price levels had already jumped by 3.9% in the first four months of 2022.
The May CPI report added fuel to the inflation fire. Price levels rose another 1% for the month, bringing the year-over-year increase to 8.6%.
What the CPI means for Social Security COLAs
The Social Security Administration (SSA) uses a simple formula to determine what the COLA will be. Each year, the SSA looks at the monthly measures for July, August, and September in the CPI for Urban Wage Earners and Clerical Workers, or CPI-W. It then takes the average of those three data points to represent the price level it uses for the current year.
To generate the COLA percentage that will take effect at the beginning of 2023, the SSA then takes the 2022 average CPI for those summer months and compares it to the 2021 average. The percentage increase becomes the COLA for the following year.
The average level for the three summer months in 2021 was 268.421. As early as April, the CPI-W had already risen enough so that even if there were no further inflation, the COLA would exceed the amount that took effect at the beginning of 2022. With a CPI-W reading of 284.575 in April, the figure was up 6% from the summer 2021 average.
May's reading of 288.022 took the prospective COLA even higher. If the CPI-W stays flat from May's level through September, then the COLA would amount to 7.3%.
A multidecade high COLA isn't cause for celebration
Remember, the idea behind COLAs isn't to make Social Security recipients better off. It's just designed to help them keep up with the higher prices they have to pay on basic necessities. Without those adjustments, retirees would be worse off. And since the price increases have already taken effect, worse off is exactly what these retirees are going to be until the next set of COLAs kicks in at the beginning of 2023.
Moreover, inflation eats away at the value of any outside savings that Social Security recipients were able to build up during their careers. Indeed, when you combine weaker purchasing power with the declines that many retirees have seen in their retirement accounts from falling prices in both the stock and the bond markets, the negative impact on financial strength is particularly difficult.
Obviously, Social Security recipients are better off getting a COLA than not getting one. What's unfortunate is the need that stems from higher prices, because inflation could continue to have wide-ranging consequences that affect not only the finances of older Americans but also their quality of life. A high COLA can remedy part of that, but the better solution would be to get prices back under control so that a big adjustment is no longer necessary.
