More than 60 million Americans are currently receiving Social Security benefits, 41.2 million of whom were retired workers as of the November snapshot from the Social Security Administration (SSA). Of these retired workers, both Gallup's survey findings and data from the SSA show that Social Security is relied upon by roughly 60% of retirees to account for at least half of their monthly income. It's fairly safe to say that without Social Security income, many of our nation's seniors could be living in poverty.
Unfortunately, the longer-term prospects for our nation's seniors -- and even the current workforce -- are somewhat grim.
According to the Social Security Board of Trustees' annual report in 2016, the program has an estimated 18 years left before its more than $2.8 trillion in spare cash is completely exhausted. While a confluence of factors are to blame for Social Security's expected spare cash depletion, most of the finger-pointing winds up aimed at the large number of baby boomers exiting the workforce and becoming eligible for benefits, as well as lengthening life expectancies. Both of these demographic shifts have been apparent for a long time, but neither were apparent to the founders of Social Security some 81 years ago. Should Social Security's spare cash be depleted, a 21% across-the-board cut in benefits may be necessary to sustain payouts through the year 2090.
In other words, current retirees (should they live to see 2034), pre-retirees, and workers who may be reliant on Social Security income to some degree when they hang up their work coat for good may see more than a fifth of their expected benefit disappear in less than two decades.
However, this expected cash shortfall may not be the biggest concern for Social Security recipients.
Medical cost inflation is leaving Social Security COLAs in the dust
Based on data from the U.S. Department of Labor, as compiled by MarketWatch, medical cost inflation has been leaving seniors completely in the dust for the past 35 years. In fact, as we've examined previously, Social Security's cost-of-living adjustment (COLA) has outpaced the medical cost inflation rate just two times over the past 35 years. Starting with a baseline of $100 in 1965, the Consumer Price index (CPI), which is the standard measure of inflation, had come close to reaching $800 by 2015. By comparison, medical cost inflation has pushed to nearly $1,800. Since 1981, the medical cost inflation rate is up around 500%, while the CPI is up less than 200%.
Why is this data meaningful? Currently, Social Security's COLA is calculated using the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. The CPI-W factors in the changed prices for a basket of goods and services for tens of millions of working Americans. The SSA then compares the baseline figure (the average CPI-W during the third quarter) from the previous year to the average CPI-W during the third quarter of the current year. If there's an increase, Social Security recipients get a "raise" equivalent to the percentage difference, rounded to the nearest 0.1%.
Sounds pretty simple and benign, right?
Here's the problem: Working Americans can have remarkably different spending habits than seniors -- yet seniors comprise two-thirds of all Social Security beneficiaries. Compared to another inflationary index that only tracks the spending habits of seniors, the Consumer Price Index for the Elderly (CPI-E), there are substantial differences noted in both housing and medical care expenditures.
A December 2011 comparison of the two indexes by the Bureau of Labor Statistics found that medical care expenditures were double for seniors compared to workers, while housing costs were also notably higher. Conversely, the CPI-W overemphasized apparel, entertainment, food, and transportation expenses, which were higher for workers than for seniors. In short, the CPI-W hasn't been keeping up with the real rate of inflation seniors are facing as a result of high medical cost inflation.
It could get worse
I wish I could say that's the end of it, but that may not be the case. Earlier this month, Sam Johnson (R-Tx.), the chairman of the Ways and Means Social Security subcommittee, introduced the Social Security Reform Act of 2016 as a way to "save Social Security."
Johnson's plan has a number of components, which include eventually raising the retirement age, raising the minimum benefit for people who've worked a lot but failed to earn a lot, eliminating the taxation of Social Security benefits, and yes, adjusting how COLAs are calculated.
In particular, Johnson advocates utilizing a chained CPI in place of the CPI-W. The chained CPI rises at a slower pace over time than the CPI-W. This is because the chained CPI takes into account the idea of consumer substitution. In other words, if a product rises in value, consumers may substitute a less expensive alternative instead of continuing to purchase that product. The CPI-W doesn't factor in substitution.
Based on the data from the U.S. Department of Labor, the chained CPI has risen from a baseline of $100 in 1965 to just around $600 by 2015. Another way of looking at it is this: Medical cost inflation has risen at a rate that's three times faster than the chained CPI over the past 50 years. This would suggest that if Johnson gets his proposal signed into law, the bifurcation between Social Security COLAs and medical cost inflation would be even more magnified in the years to come, and seniors' purchasing power would be eroded at an even faster rate than it is now.
To be crystal clear, there's no guarantee that the Trump administration or any future Congress will pass legislation that will more accurately reflect the medical costs seniors are paying each year. This means pre-retirees and workers need to now -- more than ever -- have secondary channels of income at the ready, as well as a well-planned retirement budget in place, so they aren't reliant on Social Security as a major component of their monthly income during retirement.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.