For the vast majority of aged Americans, Social Security income is indispensable. National pollster Gallup found that nearly 90% of current retirees lean on their monthly payout to make ends meet, while 84% of future retirees expect to rely on their Social Security check to some varying degree during their golden years.

Considering how important Social Security is to the financial well-being of current and future retirees, no annual announcement takes more precedence than the cost-of-living adjustment (COLA), which is due out during the second week of October.

A person counting a fanned stack of assorted cash bills in their hands.

Image source: Getty Images.

What, exactly, is Social Security's cost-of-living adjustment (COLA)?

In simple terms, COLA represents the "raise" Social Security's more than 65 million beneficiaries receive most years to account for the rising price of goods and services (i.e., inflation). "Raise" is in quotation marks to drive home the point that Social Security checks are increasing to keep payouts in lockstep with inflation. Thus, it's not a true raise in the traditional sense of the word.

For the past 47 years, Social Security's COLA determinant has been the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This is where economists breathe a sign of relief for acronyms. The CPI-W has eight major spending categories and many dozen subcategories, all with their own respective percentage weightings. This allows for countless categories to be summed up into a single number that can be easily compared to the previous month or year.

Social Security's COLA is determined using only the CPI-W readings from the third quarter (July through September) of the current and previous years. If the average third-quarter CPI-W reading from the current year is higher than the average third-quarter CPI-W reading from the previous year, beneficiaries receive a raise that's commensurate with the percentage increase, rounded to the nearest tenth of a percent.

US Inflation Rate Chart.

Historically high inflation eased a bit in July. U.S. Inflation Rate data by YCharts.

It's time to kiss that estimated 11.4% COLA for 2023 goodbye

For the upcoming year, Social Security's beneficiaries -- specifically, the 48 million retired workers receiving a monthly check -- are expecting their largest "raise" in over four decades.

A historically high inflation reading of 9.1% in June set the stage for what some policy analysts believed could be a double-digit percentage increase to Social Security checks in 2023. Mary Johnson, a policy analyst at The Senior Citizens League (TSCL), a nonpartisan senior advocacy group, opined in July that the 2023 cost-of-living adjustment could come in as high as 11.4% if the U.S. inflation rate continued to surpass expectations.

Following the release of July's inflation data from the U.S. Bureau of Labor Statistics, one thing is crystal clear: Inflation is no longer outpacing analyst expectations. With the price for crude oil falling and pain at the fuel pumps easing (if only temporarily), the prevailing inflation rate eased modestly in July. In doing so, it all but ensures that the high-end estimate of an 11.4% COLA in 2023 is now off the table.

To add to this point, Social Security recipients are liable to lose much or all of their historically high COLA in 2023 to rising costs. Over the past 12 months, the Consumer Price Index for All Urban Consumers (CPI-U) -- a similar inflationary measure to the CPI-W -- showed a staggering 13.1% increase for food at home, a sizable 5.7% hike in shelter expenses, and a 5.1% boost in medical care service costs. These are all important expenditures for aged Americans and a good indication that their COLA will likely be eaten up by higher costs in the coming year.

A visibly concerned person with their chin resting on their balled hands.

Image source: Getty Images.

Retired workers have been getting the short end of the stick for over two decades

However, having their Social Security income gobbled up by rapidly rising prices is nothing new for retired workers. In fact, for more than 20 years, aged Americans have been getting the short end of the stick from America's top social program.

Back in May, TSCL issued a report showing that the purchasing power of Social Security dollars has fallen by a jaw-dropping 40% since 2000.  In other words, what $100 in Social Security income could buy in 2000 can now only purchase $60 worth of those same goods and services. Even though aggregate Social Security checks are rising over time, they're not coming anywhere close to keeping pace with the inflation aged Americans are actually contending with.

If you're wondering how this is even possible, look no further than the CPI-W. As its full name suggests, this is an inflationary index tracking the spending habits of "urban wage earners and clerical workers." These are typically working-age people who aren't receiving a Social Security benefit. More importantly, their spending habits tend to differ significantly from senior citizens. As a result, key expenditures for retired workers tend to be underweighted in the CPI-W, while less-important costs, such as apparel and education, receive higher weightings.

In short, the CPI-W does a poor job of measuring inflation for the majority of Social Security beneficiaries. It really doesn't matter how large the cost-of-living adjustment is in 2023; seniors are almost certain to see the purchasing power of their Social Security dollars continue to decline over time.