For better or worse, Social Security is our nation's most prized social program. It's certainly not going to make any of us rich when we retire, but it's been responsible for providing a basic level of financial dignity for millions of retired Americans for almost 80 years. An analysis from the Center on Budget and Policy Priorities finds that 22.1 million people -- that's more than a third of all current beneficiaries -- are kept out of poverty as a direct result of their guaranteed monthly payout.
With this being said, there's arguably no news event that retired workers, who represent about 70% of the program's nearly 63 million beneficiaries, await more than the annual cost-of-living adjustment (COLA) announced during the second week of October. This COLA announcement by the Social Security Administration (SSA) lets beneficiaries know how much of a raise they'll be receiving in the upcoming year.
Here's how your Social Security COLA is calculated
Before we go any further, I think it's important to have a basic understanding of how COLA is determined. Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been the program's inflationary tether. Prior to this point, benefit increases to match perceived inflation rates were passed along via special congressional votes. For instance, there was no COLA passed along during the entirety of the 1940s!
Nowadays the process for calculating COLA is pretty simple. In fact, anyone interested can calculate it for themselves and not have to wait for an announcement from the SSA. The average CPI-W reading from the third quarter of the previous year (July through September) acts as your baseline figure, while the average reading from the third quarter of the current year is the comparison. The CPI-W readings during the other nine months of the year do not factor into the COLA calculation. If the current-year average is higher than last year's average reading, then beneficiaries will receive a raise commensurate with the percentage increase, rounded to the nearest 0.1%.
In rare instances, deflation can occur. This is when the price of goods and services in the CPI-W's basket goes down in the current year from the previous year. Should this happen, Social Security benefits remain static from one year to the next. Thankfully, deflation can't cause Social Security benefits to be reduced. A 0% COLA has occurred only three times since 1975 (2010, 2011, and 2016).
A goose egg could follow the most robust raise in seven years
In 2019, most Social Security beneficiaries are enjoying their 2.8% COLA, which is the largest percentage raise in seven years. But another big raise doesn't look to be in the cards for 2020. In fact, there's a possibility that beneficiaries may not receive a COLA at all for the fourth time in 11 years.
Over the past two years, energy has been a primary driver of the CPI-W. Even though it only has a relatively small weighting compared to shelter expenses (as an example), double-digit increases in gasoline and fuel oil pricing during the third quarter in 2017 and 2018 played a big role in pushing the CPI-W higher. Well, that and the fact that the three months that factor into the CPI-W are prime hurricane months for the U.S., leading to occasional drilling and/or refining disruptions that can dramatically raise prices at the pump. This is what happened in 2017, when Hurricanes Harvey and Irma wreaked havoc on the energy sector, leading to a bump-up in Social Security's COLA for 2018.
Since the beginning of October, prices at the pump have been in free fall. Sure, some of this could be due to the refining industry switching to a traditionally cheaper winter fuel mixture. But a big portion of this decline in gasoline prices is tied to West Texas Intermediate crude oil falling from around $75 a barrel to $50 a barrel. In November, gasoline, as measured by the Consumer Price Index for All Urban Consumers (CPI-U), a similar inflationary measure to the CPI-W, fell 4.2% from the preceding month. Then, in December, the price of gasoline tumbled another 7.5% from the preceding month. On a 12-month unadjusted annualized basis, gasoline prices are down 2.1%. Comparatively, over the past two years the price of gasoline has been up by 20%-plus on an unadjusted 12-month basis!
If there is some good news from the Bureau of Labor Statistics data, it's that shelter inflation (e.g., rent) remained robust at an unadjusted increase of 3.2% over the trailing 12-month period through December. Shelter inflation represents about a third of the weighting for the CPI-U, and a high weighting as well for the CPI-W.
But even here there are concerns. CNBC reported this past week that California's home sales fell 20.3% year over year in December. This represents the slowest December sales pace for homes in the Golden State since 2007. Given that California is often viewed as a leading indicator for the housing industry, its rapidly weakening prospects suggest that shelter inflation may also come under pressure.
If shelter inflation were to noticeably lessen, energy prices declined by a mid-to-high single-digit percentage from the previous year, and no major hurricanes disrupt production in the Gulf of Mexico this coming summer, it's not out of the question that beneficiaries receive no COLA in 2020.
However, there is an important point to be made for this assessment: It's an estimate. A lot can happen between the data we'll soon be viewing for January and the data that actually counts between July and September. Similarly, no one can predict the weather with concrete accuracy. There remain plenty of avenues for COLA to rise in 2020. Just understand that a path also clearly exists for COLAs to stagnate once again.