You may not like what I'm about to say, but it's the truth: There's a very good chance that you're going to be reliant on Social Security income, in some capacity, during retirement.
For those already retired, an April 2018 Gallup survey finds that 90% of seniors lean on the program in some varied capacity to make ends meet, including 57% who rely on Social Security as a "major" income source. Meanwhile, if retirement is coming up in a few years, or perhaps decades down the road, Gallup's survey finds that 84% of nonretirees expect to lean on their Social Security retirement benefit, at least to some degree.
With only a small percentage of Americans not expected to need their Social Security income during retirement, there are few things that'll take greater precedence for seniors than when they claim Social Security benefits and what their annual cost-of-living adjustment will be. Unfortunately, the latter of these two events could prove to be a disappointment far more years than not.
A crash course in how Social Security's cost-of-living adjustment is calculated
Ideally, Social Security's cost-of-living adjustment, or COLA, is supposed to pass along a "raise" to the 62 million-plus Social Security beneficiaries that perfectly accounts for the inflation that they've faced. However, passing along an accurate raise to beneficiaries -- specifically seniors -- rarely happens.
Social Security's inflationary tether is the same today as it's been since it first began keeping track of inflation for America's most important social program in 1975: the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W is designed to measure how the price of an identical basket of goods and services changes over time. With this in mind, let's take a closer look at how COLA is calculated.
The Social Security Administration uses the average reading of the CPI-W during the third quarter of the previous year (July through September) as its baseline and compares it to the average reading of the CPI-W during the third quarter of the current year. You'll note that the inflation reading from the other nine months has absolutely no bearing on COLA. If the average CPI-W reading has risen in the current year from the previous year, then beneficiaries will receive a raise that's commensurate with the percentage increase, rounded to the nearest 0.1%. If the CPI-W were to fall year over year, then benefits remain static. Thankfully, Social Security benefits can't drop as a result of price deflation.
Here's why your Social Security COLA isn't keeping up with inflation
Based on this explanation, it probably sounds like most beneficiaries get a pretty fair shake when it comes to receiving raises each year -- but that's far from the truth. According to an analysis from The Senior Citizens League, seniors have seen the purchasing power of their Social Security benefits decline by 34% since the year 2000.
What gives, you ask? The answer lies with an inherent flaw in Social Security's inflationary tether. Though you might think it's the fact that only 3 of 12 months are taken into account each year (and this may well play a small role), the real issue is that the CPI-W, as its full name implies, takes into account the spending habits of urban and clerical workers.
Are there urban and clerical workers receiving Social Security benefits? Most likely, yes. But they make up a very small percentage of aggregate recipients. Out of the nearly 62.5 million people who received a benefit in July 2018, 69.2% of them were retired workers who, by law, must be at least 62 years of age. In other words, Social Security is basing "raises" to be given predominantly to seniors on the spending habits of working-age urban and clerical workers, who rarely are receiving Social Security benefits. And, as you're probably realizing by now, working-age urban and clerical workers and the elderly don't spend their money the same way.
For example, in 2011, the Bureau of Labor Statistics (BLS) compared the Consumer Price Index for the Elderly (CPI-E) -- an inflationary measure that takes into account the spending habits of households with persons aged 62 and over -- and the CPI-W. It found that the elderly spend twice as much of their income on medical care, in percentage terms, as urban and clerical workers do based on the CPI-W.
Further, seniors spend a notably higher percentage of their income on housing relative to urban and clerical workers. Not surprisingly, the inflation rate for housing and medical care has consistently run higher than most other costs for the past two decades. What this means is that the CPI-W isn't giving these expenditures adequate representation when calculating COLA each year, which is shortchanging senior citizens.
So what is getting the representation that medical care and housing should be getting? The BLS side-by-side comparison found that transportation, food and beverage, education and communication, and apparel costs were given this extra weighting.
In short, your Social Security benefit isn't keeping pace with inflation because the tether designed to measure inflation is inherently flawed with regard to the very group of people Social Security is designed to protect.