The Federal Reserve tries to keep inflation at 2%, but a combination of factors -- from stimulus checks and loose monetary policy to supply chain disruptions and geopolitical conflict -- have caused prices to rise much more quickly lately. In fact, inflation hit a 40-year high of 9.1% in June, and it has exceeded the Fed's target for the last 17 months.
Fortunately, the Social Security Administration (SSA) enacts a cost-of-living adjustment (COLA) each year to protect the buying power of benefits. In light of the trajectory inflation has followed this year, the COLA could be as high as 8.7% next year, according to The Senior Citizens League. That would be the largest COLA since 1981.
That said, many seniors may still feel like they have less money in 2023. Here's what you should know.
The problem with the way COLAs are calculated
Since 1975, the SSA has measured inflation and calculated COLAs using the Consumer Price Index for Urban Wage Earnings and Clerical Workers (CPI-W), a metric based on purchases made by office workers and other hourly wage earners across eight major spending categories.
Unfortunately, the spending patterns of working-age individuals are a poor representation of the spending patterns of seniors. People in the workforce typically spend more money on food, education, transportation, and apparel, while seniors tend to pay more for medical care and housing. That discrepancy means there is a problem with the way COLAs are calculated.
To illustrate the problem, consider the following: The standard Medicare Part B premium rose 14.5% in 2022, and by last month, the price of electricity and home heating oil had soared 15.8% and 68.8%, respectively, in the previous 12 months. All of those figures are noticeably higher than the 8.7% increase in the CPI-W over the past year. That's because the CPI-W underemphasizes spending categories that are more relevant to seniors, and it overemphasizes spending categories that are less relevant.
COLAs have failed to keep pace with inflation
Seniors have seen their expenses grow more than twice as quickly as COLAs since Jan. 2000, and that has caused Social Security benefits to lose 40% of their buying power during that time, according to The Senior Citizens League. To quote policy analyst Mary Johnson, "For every $100 of goods or services that retirees bought in 2000, today they would only be able to buy $60 worth."
That means seniors have already seen their Social Security benefits stretched thin by rising prices as COLAs have not kept pace with inflation over the last two decades. And unless changes are made to the Social Security program, that trend will likely continue in the coming years.
Is there a solution? Some experts believe COLAs should be calculated using the Consumer Price Index for the Elderly (CPI-E), a metric based on the spending patterns of individuals 62 years of age and older. In fact, legislation currently sits before Congress that would replace the CPI-W with the CPI-E, though it could be a while before any definitive action is taken.
With that in mind, seniors must continue to carefully budget their money and look to cut costs where possible. Even if 2023 brings the biggest COLA in the last four decades, odds are that extra cash will be eaten away (and then some) by rising prices.