Social Security provides tens of millions of Americans with retirement benefits, and many recipients rely on Social Security for the majority of their retirement income. Yet retirees have had to put up with little or no increase in their Social Security checks over the past couple of years, and even when you look back further, the annual boosts to monthly checks have been puny at best.

Fortunately for those who live on fixed incomes, there's reason to believe that 2018 might be different. Based on early projections of the figures that the Social Security Administration (SSA) uses, the annual cost of living adjustment (COLA) that Social Security recipients receive could be the biggest since 2012. That would finally provide some relief for those who've seen their checks stay almost the same since the end of 2015.

Social Security cards with key.

Image source: Getty Images.

How the SSA will calculate the 2018 Social Security increase

The idea of the cost of living adjustment is to compensate retirees for the impact of inflation. In order to calculate the COLA, the SSA looks at inflation as measured by the Consumer Price Index for urban wage earners, or the CPI-W for short.

Although the Social Security COLA takes effect in January, the numbers that the SSA uses are available earlier. Specifically, the CPI-W figures for the months of July, August, and September are what go into the calculation for the cost of living adjustment. To figure the COLA, you take the average CPI-W reading for those three months and then compare it to the average during the same period in the previous year. The percentage difference between the two averages is the amount of the COLA for that year. However, a special rule makes it impossible for COLAs to be negative, so at worst, Social Security checks stay the same during periods of flat or lower price levels.

Over the past couple of years, we saw the impact of deflation on COLAs. The CPI-W levels in the summer of 2015 were lower than those in 2014, so there was no inflation adjustment that took effect at the beginning of 2016. Then, last year, the summer 2016 CPI-W readings rose substantially, but they first had to catch up with the decrease from the previous year. The inflation index did so, but it only managed an additional 0.3% rise beyond that, making 2016 and 2017 the worst period for COLAs since the post-recession period of 2010 and 2011.

Why the COLA could bubble higher for 2018

Readings on the CPI-W don't come out until the middle of the following month, so we won't have a final answer on changes in inflation for the summer months until mid-October. However, we've already seen a sizable pickup in upward movement in the CPI-W. The April 2017 figure of 238.432 is higher than the 2016 three-month average of 235.057 by more than 1.4%. At first glance, that would seem to suggest a COLA in the neighborhood of the 1.5% to 1.7% that we saw in the period from 2013 to 2015.

However, there are still several months between now and the measuring period for 2018's Social Security increase. When you look at year-over-year figures, the increases in the CPI-W have been running above the 2% mark, with figures as high as 2.8% in February. If inflation were to pick up steam from here, then the COLA could end up being the biggest since the 2012 adjustment of 3.6%.

Why high COLAs aren't all good

Of course, larger cost of living adjustments come at a price: They suggest higher inflation, which eats into the purchasing power of all consumers. For retirees on fixed incomes, inflation is particularly onerous, because they aren't earning wages that tend to follow inflationary trends higher over time.

It's too early to tell exactly what the 2018 Social Security increase to benefits will be, but the signs are pointing to the largest increase for Social Security recipients in years. Many seniors will see that as good news, but you should also watch the prices you're paying to see if the COLA you end up getting actually compensates you for price increases for the things you need.