The numbers don't lie: Social Security is the U.S.'s most vital social program. According to the Center on Budget and Policy Priorities, Social Security is responsible for pulling almost 22.5 million people out of poverty each year. More importantly, it's lowered the poverty rate among senior citizens to 9% from an estimated 38%, if Social Security didn't exist.
Surveys have shown that the vast majority of working Americans expect to rely on their Social Security income, to some varied degree, when they retire. National pollster Gallup found that a combined 84% of nonretirees anticipate leaning on Social Security as a "major" or "minor" source of income during their golden years.
Because of Social Security's importance to the financial well-being of tens of millions of Americans, there's arguably no announcement more important than the annual cost-of-living adjustment (COLA).
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Understanding Social Security's cost-of-living adjustment
The easiest way to think about COLA is as the "raise" passed along to the program's beneficiaries most years. But as you'll note by my placing "raise" in quotation marks, this isn't a typical raise like you'd receive from an employer. COLA is a benefit boost that's solely designed to help recipients keep up with the inflation they're contending with. In other words, if the price for goods and services rises, Social Security benefits should, ideally, increase so beneficiaries can still purchase the same amount of goods and services.
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) (thank goodness for acronyms!) has been Social Security's inflationary tether. The CPI-W has eight major spending categories and a multitude of subcategories, each with their own respective percentage weightings. These weightings are what allow us to arrive at a single CPI-W reading that can be compared to previous months or years to determine if inflation (rising prices) or deflation (falling prices) have taken place.
However, only the CPI-W readings from the third quarter (July to September) are used to calculate Social Security's cost-of-living adjustment. While the other nine months can be helpful in identifying trends, they won't influence whether beneficiaries receive a "raise" in the upcoming year.
If the average CPI-W reading from the third quarter of the current year is higher than the average CPI-W reading of Q3 from the previous year, Social Security's recipients are getting a "raise." The amount of the raise is the percentage increase in the average Q3 CPI-W reading from the previous year, rounded to the nearest tenth of a percent.
A multidecade high for the U.S. inflation rate could send Social Security checks soaring in 2023. U.S. Inflation Rate data by YCharts.
How does an extra $192 per month sound?
In 2023, Social Security's COLA could well make history. While it won't be anywhere near the largest cost-of-living adjustment in history, it has a chance to be the largest nominal-dollar increase to Social Security checks by a substantial amount.
A little over two weeks ago, The Senior Citizens League (TSCL), a nonpartisan senior advocacy group, released a report outlining their thoughts on where Social Security's COLA could head in the coming year. According to TSCL Social Security policy analyst Mary Johnson, there is a wide range of outcomes. If inflation cools between July and September, COLA could come in at "just" 9.8%. However, if inflation continues to pick up during the summer months, Social Security's COLA could be a blistering 11.4% in 2023. For context, the U.S. inflation reading in June hit a four-decade high of 9.1%.
What might an 11.4% COLA look like in dollar terms for the average retired worker? As of June 2022, the average monthly benefit for 47.9 million retired workers was $1,669.44. Typically, this average payout increases by about $2 a month, which has to do with newly retired workers entering the pool of recipients. Therefore, by December 2022, the average monthly benefit for retired workers should be approximately $1,683.
If inflation were to run hot and Social Security's COLA hits Johnson's high-end estimate of 11.4%, the average retired worker would be looking at a $192 per month increase to their Social Security check come January 2023. This would equate to an average take-home check of $1,875 per month.
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Social Security beneficiaries could face a double whammy in 2023
A $192 per month "raise" would represent the largest year-over-year nominal-dollar benefit hike in Social Security's history. To boot, an 11.4% COLA would be the second-largest percentage increase since the CPI-W became the program's inflationary tether.
But despite this potentially historic increase in monthly benefits, it's not all peaches and cream for the program's more than 65 million recipients.
To begin with, a multidecade high cost-of-living adjustment implies that beneficiaries are contending with rapidly rising costs. There's a good chance that most or all of the "raise" beneficiaries receive in 2023 will be eaten up by the rising cost of food, shelter, medical care, electricity, and a host of other spending categories. And that's not all.
The double whammy for program recipients is that the purchasing power of Social Security income has been falling for more than two decades. A TSCL report from earlier this year found that the purchasing power of Social Security dollars has declined by 40% since 2000. An 11.4% cost-of-living adjustment wouldn't do much to close the purchasing power gap that's existed for 22 years (and counting).
The reason for this persistent purchasing power decline is that the CPI-W does a poor job of accounting for the inflation that seniors are facing. The CPI-W is designed to track the spending habits of urban and clerical workers, most of whom are of working age and not receiving a Social Security benefit. The end result is that the CPI-W underweights key expenditures for seniors, such as shelter and medical care, while putting greater emphasis on less important costs, such as apparel and education.
There's no easy fix for Social Security's purchasing power dilemma, which means even a historically high COLA in 2023 won't help retired workers much, if at all.
