When discussing America's most important social programs, Social Security is arguably at the top of the list. Aside from the fact that 62.5 million people are receiving a benefit check each month, more than three out of five retired workers (which comprise 69% of the aforementioned 62.5 million beneficiaries) are reliant on the program to provide at least half of their monthly income.

Keeping this important statistic in mind, there's perhaps no more anticipated event each year than the mid-October cost-of-living adjustment announcement from the Social Security Administration. This cost-of-living adjustment, or COLA, takes into account the rising cost of goods and services and determines what sort of "raise" beneficiaries will receive in the upcoming year. And while there are still a good two and a half months to go before definitively knowing what magnitude of raise to expect, signs are pointing to beneficiaries receiving their highest COLA since 2012. 

A Social Security card wedged in between cash bills.

Image source: Getty Images.

Here's how Social Security calculates its cost-of-living adjustment

But before we dig into these signs, it first helps to understand how COLA is calculated. The inflationary tether Social Security uses is the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. The average reading of the CPI-W during the third quarter of the previous year (July-September) acts as the baseline number, while the average reading during the third quarter of the current year is the comparison. If the cost of goods and services measured by the CPI-W has risen on a year-over-year basis, the percentage increase, rounding to the nearest 0.1%, is passed along to beneficiaries.

Conversely, if prices fall from one year to the next, as they did in 2010, 2011, and 2016, no COLA is passed along, and benefits remain static from one year to the next.

You might then be wondering, what actually factors into this inflationary tether? Though there are plenty of subcategories, there are eight primary spending categories that matter:

  1. Food and beverages
  2. Housing
  3. Apparel
  4. Transportation
  5. Medical care
  6. Recreation
  7. Education and communication
  8. Other goods and services

Thus, the rising cost of food, medical care, gasoline, rental costs, and much more, should be counted by the CPI-W and passed along as an inflation-matching "raise" to beneficiaries in the following year.

A person pumping gas into their car.

Image source: Getty Images.

This is why things are looking up for Social Security recipients in 2019

What should have existing beneficiaries somewhat excited about the upcoming COLA announcement in October is that the CPI-W has been steadily climbing in recent months. After logging a 3% unadjusted change over the trailing-12-month period as of May, according to the Bureau of Labor Statistics (BLS), the CPI-W jumped to a 3.1% unadjusted increase on a year-over-year basis as of June.

Similar increases were witnessed with the Consumer Price Index for All Urban Consumers, or CPI-U. The CPI-U, which measures many of the same spending categories as the CPI-W, has had its unadjusted 12-month inflation rate increase in five consecutive months, from 2.1% in January 2018 to 2.9% in June 2019.

According to the BLS, the bulk of this inflationary increase is the result of higher energy commodity prices (i.e., higher crude prices that lead to more expensive prices at the pump, and for fuel oil), as well as higher shelter expenses. In fact, few subcategories have seen a year-on-year decline in prices, with autos sales, airline fares, and televisions, as examples, being the rare exception of late. Relative to the CPI-U, energy commodities comprise a 4.69% weighting in the index (they're up 24% on an unadjusted 12-month basis), while shelter expenses, which are up 3.4% over the trailing 12 months, comprise a hefty 32.71% weighting. 

Long story short, inflation has been trending up all year thanks to higher crude prices and rental inflation. That bodes well for a continuation of this pattern in July, August, and September, which are the three months that actually determine Social Security's COLA in the upcoming year. My best guess, assuming we have a moderate hurricane season and face modest refining disruption, is that COLA could come in at either 3.2% or 3.3% in 2019. That would represent a seven-year high.

A disappointed senior woman in deep thought, with her arms crossed and her head resting on her arms.

Image source: Getty Images.

Social Security's COLA is failing seniors

Unfortunately, even the biggest raise in seven years isn't something for seniors to necessarily break out the champagne over.

According to an analysis from The Senior Citizens League, Social Security's purchasing power has declined by a whopping 34% since the year 2000. Put in another context, what seniors were able to buy with $100 worth of Social Security income in 2000 would now only purchase $66 worth of the same goods and services.

How's this possible? The issue is in the CPI-W itself.

As the inflationary tether suggests, it measures the expenditures of urban and clerical workers, who have markedly different spending habits than senior citizens. And, mind you, seniors comprise more than two-thirds of all beneficiaries. What therefore happens is important costs for seniors, such as housing and medical care, get underrepresented since they don't cost working-age urban and clerical workers nearly as much, based on their percentage of total expenditures. Meanwhile, food, transportation, apparel, and other expenses that would be significantly lower for seniors relative to urban and clerical workers, get added emphasis by the CPI-W. The result is an annual COLA that simply doesn't match the inflation that seniors are contending with.

Don't get me wrong -- a 3.2% or 3.3% COLA, should my prognostication prove accurate, would be positive news for tens of millions of retired workers. But, to be crystal clear, it's not exactly going to help them get ahead of the inflationary curve.