As of May, more than 62 million people were receiving a Social Security benefit, of which nearly 45 million were aged beneficiaries (ages 65 and over). Of these older Americans, the Social Security Administration (SSA) finds that 62% lean on the program to provide at least half of their monthly income, with 34% reliant on Social Security for essentially all of their income (90% or more). All told, it's a program that's singlehandedly kept around 15 million seniors above the federal poverty level. 

Given its relative importance in helping to form a financial foundation for retired workers, there's perhaps no announcement from the SSA that's more anticipated each year than the mid-October release of Social Security's cost-of-living adjustment, or COLA.

Two Social Security cards lying next to hundred dollar bills and atop a payment calculation table.

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Understanding the quirks associated with Social Security cost-of-living adjustments

COLA is nothing more than the "raise" that eligible beneficiaries will receive once the new year begins. It's designed to take into account the inflation – i.e., the rising price of goods and services – that beneficiaries face, and pass along an appropriate increase in benefits from one year to the next to account for that inflation. Of course, accounting for inflation isn't as cut-and-dried as you might think.

The current inflationary tether used by the SSA is the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). As the name implies, this is an inflationary tool that focuses on the expenditures of urban and clerical workers, not on the spending habits of retired workers. The result is that less weighting is given to medical care and housing expenditures, which simply aren't as high for working-age Americans as they are for seniors. Meanwhile, more weighting is assigned to apparel, transportation, food and entertainment, and other categories that seniors spend less on, relative to working-age Americans.

In other words, the inflation that seniors face tends to be underreported by the CPI-W. Nevertheless, it's been the go-to measure of inflation determining the raise that's passed along to all beneficiaries in the following year since COLA was first introduced 1975 for those receiving benefit checks in 1976.

Another interesting aspect of the COLA process is that it doesn't take into account the inflationary data for a full year. Instead, the average CPI-W reading from the third quarter of the previous year (July through September) acts as the baseline, and the average CPI-W reading from the third quarter of the current year is the comparison. The difference, expressed as a percentage and rounded to the nearest 0.1%, is what's passed along as a raise to beneficiaries. And, should prices fall year-over-year, which has occurred three times since 2010, benefits remain static from one year to the next. They'll never decline due to deflation.

It's also worth pointing out that since the Bureau of Labor Statistic usually doesn't report monthly inflation data until the end of the second week of the following month, beneficiaries have to wait until mid-October to get an official announcement on COLA from the SSA.

A senior man counting a fanned pile of cash in his hands.

Image source: Getty images.

What might Social Security's COLA deliver in 2019?

What you're probably wondering right now is what Social Security's COLA might look like for 2019. While nothing is set in stone, given that we don't even have data from the three months that actually count (July-September), as an early glimpse I'd suggest that there's a good chance it could be the biggest raise since 2012, with a slim possibility of it being the largest raise in a decade.

Back in 2012, Social Security beneficiaries received a 3.6% raise, which was the largest COLA since the 5.8% increase passed along in 2009. In each of the other years since 2009, COLA has ranged between 0% (2010, 2011, and 2016) and a pedestrian 2% (2018). 

According to the May inflation data release from the BLS, which primarily tracks the Consumer Price Index for All Urban Consumers (CPI-U), the CPI-W has increased exactly 3% on a trailing-12-month basis. To reiterate, the data from May, and all subsequent months this year, won't have any bearing on Social Security's 2019 COLA. It does, however, offer insight to the inflationary trends that could help narrow down the expected COLA for next year.

The CPI-U inflation data, which is similar to the CPI-W, shows that energy has been the primary driver of higher prices. On an unadjusted 12-month basis, aggregate energy prices have risen by 11.7% as of May 2018, with gasoline and fuel oil costs up by 21.8% and 25.3%, respectively. Shelter and transportation services also saw increases of 3.5% and 3.8%, respectively. Meanwhile, new and used vehicles are the only line items to have observed year-on-year deflation over the past 12 months. 

With the summer driving season kicking into full swing, and prices at the pump soaring in the wake of four-year highs for crude oil prices, energy commodities have a really good shot (at least right now) of carrying Social Security's 2019 COLA above the 3% mark. Keep in mind that hurricanes Harvey and Irma, which disrupted production and refining capacity throughout the Gulf of Mexico and the southeastern U.S. last year, played a critical role in lifting COLA by 2% for 2018. If this hurricane season is anything like last year's, any extended disruption in the domestic refining industry could give Social Security's COLA an outside chance of eclipsing 3.6%, as it did in 2012, ultimately pushing it to a 10-year high. 

An elderly man clutching onto his piggy bank as outstretch hands reach for it.

Image source: Getty Images.

Not to be a party-pooper, but...

On the bright side, Social Security beneficiaries could be looking at only their second meaningful increase, in percentage terms, in a decade. But, truth be told, a COLA in the neighborhood of say 3% to 3.5% still doesn't change the fact that Social Security benefits have been losing purchasing power over time.

A recently released analysis from The Senior Citizens League finds that Social Security benefits have lost 34% of their purchasing power since the year 2000. Put another way, what $100 in Social Security income used to be able to buy in 2000 now only buys $66 worth of goods and services.

What's the reason for this decline? Put simply, the costs for a number of items, such as Medicare Part B premiums which have nearly tripled since 2000, have increased at a much faster pace than Social Security's COLA. And at the heart of this problem is the fact that Social Security's inflationary tether, the CPI-W, doesn't do a very good job of reflecting the inflation that senior citizens are dealing with.

One solution offered by Democrats on Capitol Hill is to replace the CPI-W with the Consumer Price Index for the Elderly (CPI-E). The CPI-E would specifically factor in the expenditures of households with persons ages 62 and over, likely providing a more accurate measure of the inflation that senior citizens are facing. With more emphasis placed on medical care and housing, a higher COLA should follow.

However, the consequence of adjusting to the CPI-E from the CPI-W is that it would drain Social Security's $2.9 trillion in asset reserves even faster than the Trustees have projected. The often higher COLA's associated with the CPI-E haven't been factored into the Trustees' projections, so the 2034 date at which Social Security's asset reserves are expected to be depleted could come even sooner if the CPI-E is used.

In short, an expected 3%-plus COLA in 2019 isn't as big of a win for seniors as it might appear on the surface.

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