For most aged Americans receiving a Social Security check each month, this income is indispensable. According to an April poll by Gallup, 89% of surveyed retirees rely on their monthly benefit to some degree to make ends meet.
Given how important Social Security is to the financial well-being of our nation's retired workforce, there's no announcement more anticipated than the cost-of-living adjustment (COLA), which will be announced on Oct. 13, 2022, at 8:30 a.m. ET.
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How is Social Security's cost-of-living adjustment (COLA) calculated?
In simple terms, COLA is the mechanism designed to help Social Security's more than 65 million beneficiaries keep up with inflation -- i.e., the rising price of goods and services. If recipients count on their Social Security income to help them pay for a specific basket of goods and services, ideally, benefits should increase in lockstep with the inflation rate to ensure beneficiaries don't lose purchasing power. COLA is the increase passed along most years that accounts for inflation.
Since 1975, 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 and a multitude of subcategories, each of which have their own percentage weightings. This way the price moves of a large predetermined basket of goods and services can be broken down to a neat and tidy monthly figure that expresses whether inflation or deflation (falling prices) has occurred on a year-over-year or month-over-month basis.
To calculate Social Security's cost-of-living adjustment, the average CPI-W reading from the third-quarter (July September) of the current year is compared to the average third-quarter CPI-W reading from the previous year. While the CPI-W is reported monthly, only readings from the third quarter factor into the COLA calculation.
If the average third-quarter CPI-W reading rises from one year to the next, inflation has occurred and beneficiaries are in-line for a boost to their Social Security checks in the upcoming year. The amount of this increase equates to the year-over-year percentage rise in the average third-quarter CPI-W readings, rounded to the nearest tenth of a percent.
Historically high inflation should send Social Security checks soaring in 2023. US Inflation Rate data by YCharts.
Social Security checks are on track for a hefty increase in 2023
With the U.S. inflation rate hitting its highest level in more than four decades, Social Security's recipients can expect to receive a historic benefit increase.
Based on CPI-W data from July and August, Social Security's COLA is on track to grow by 8.8% in 2023. However, this figure is incomplete since it doesn't include September's inflation data, which is set to be reported on October 13.
According to Mary Johnson, a Social Security policy analyst at nonpartisan senior advocacy group The Senior Citizens League (TSCL), the cost-of-living adjustment for 2023 is expected to come in at 8.7%. This would mark the biggest percentage increase to benefits in 41 years, and would easily be the largest nominal-dollar boost in history to Social Security checks.
What, exactly, would an 8.7% cost-of-living adjustment look like in dollar terms for the average Social Security beneficiary? By December 2022, I estimate the average monthly benefit paid to retired workers, disabled workers, and survivors ("survivors" includes nondisabled and disabled widow(er)s, parents and children of deceased workers, and widowed mothers and fathers) will be as follows:
- Average retired worker benefit: $1,679.54
- Average disabled worker benefit: $1,364.54
- Average survivor benefit: $1,333.93
If Johnson's COLA forecast of 8.7% proves accurate, here's what these average beneficiaries can expect come 2023:
- Average retired worker check: $1,825.66 (an extra $146.12 per month)
- Average disabled worker check: $1,488.25 (an extra $118.71 per month)
- Average survivor check: $1,449.98 (an extra $116.05 per month)
In other words, a lot of aged Americans could be looking at a three-digit nominal-dollar increase to their monthly Social Security check next year.
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Keep the champagne on ice
But just because Social Security benefits are on pace for a historic boost, it doesn't mean the program's beneficiaries should break out the champagne. Even with a forecast 8.7% cost-of-living adjustment for 2023, two headwinds could very well lead to disappointment.
First of all, inflation threatens to eat up a significant portion of next year's benefit increase. The only reason COLA is expected to reach a 41-year high in percentage terms is because the cost of shelter, food, energy, and a number of other products and services, have skyrocketed over the past year. Chances are good that beneficiaries will paying out most, or possibly all, of their increase to cover the rising cost of goods and services.
The other issue has been persistent for over two decades: A loss of purchasing power. According to a TSCL report released in May, the purchasing power of Social Security income for retirees has plunged by 40% since 2000.
The reason for this decline is straightforward: The CPI-W does a poor job of tracking the expenses that matter most to seniors. As its full name implies, the CPI-W is designed to track the spending habits of "urban wage earners and clerical workers." These are typically working-age people who spend their money very differently than the senior citizens who make up the lion's share of Social Security's beneficiaries. As a result, key expenditures, such as shelter and medical care, are underweighted in the CPI-W calculation, while less-important costs to seniors receive added weighing.
The real kick in the pants is that lawmakers on Capitol Hill are aware the CPI-W isn't doing its job, but they can't agree on a common-ground solution to fix the problem. In other words, no matter how large COLA is in 2023 or the years thereafter, it's likely we'll see the purchasing power of Social Security income continue to decline.
