Though all eyes are on the upcoming election in less than three weeks, the most important day of the year for tens of millions of U.S. senior citizens occurred this past Tuesday, Oct. 13. That's when the U.S. Bureau of Labor Statistics released inflation data from September, providing the final puzzle piece to allow for the calculation of Social Security's cost-of-living adjustment.
Social Security beneficiaries are getting a raise next year. It won't, however, be much to write home about.
Before getting into the details of how much extra beneficiaries can expect to receive each month in 2021, let's first take a look at how the Social Security Administration calculates its annual inflationary increase.
A detailed explanation of how Social Security's COLA is determined
Prior to 1975, increases in Social Security benefits were assigned arbitrarily by special sessions of Congress. In fact, throughout the 1940s (payouts began Jan. 1, 1940), not a single COLA was passed along to beneficiaries. Without adjustments, the real value of Social Security income declined throughout the decade. COLA isn't a "raise" in the true sense of the word, so much as a truing-up of payouts to keep pace with inflation.
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers has been the program's inflationary tether. There are eight major spending categories and dozens upon dozens of subcategories, each with their own respective weighting. Added together, the CPI-W produces a tidy single figure each month that can be compared to previous months or years to determine if prices for a predetermined basket of goods and services are rising or falling.
What's interesting about Social Security's COLA calculation is that it doesn't take into account all 12 months of the year. Instead, only the CPI-W readings from the third quarter (July through September) factor into the calculation. The other nine months can be useful in determining inflation trends, but they'll have no bearing on how much of a "raise" beneficiaries will receive in an upcoming year.
To determine Social Security's COLA, the average CPI-W reading from the third quarter of the current year is compared to the average CPI-W reading from the third quarter of the previous year. If the average CPI-W reading from Q3 of the current year is higher, inflation has occurred. This means Social Security recipients will receive a bump up in their monthly payout in the following year that's commensurate with the percentage increase in the average Q3 CPI-W reading, rounded to the nearest tenth of a percent.
In the rare event that deflation occurs (i.e., falling prices), benefits remain static from one year to the next.
Social Security recipients are getting a raise
As recently as May, things looked dire for the seniors who count on Social Security as a substantial portion of their monthly income. The coronavirus disease 2019 (COVID-19) pandemic had pushed energy prices off a cliff, with significant deflation in transportation and auto sales as well. In other words, there was concern that 2021 would be only the fourth year since 1975 in which no COLA was passed along.
Thankfully, this wasn't the case. Inflation has picked back up since June. This translated into an announced 1.3% Social Security COLA for 2021.
According to BLS inflation data from September, the CPI-W reading for the month came in at 254.004. The Consumer Price Index for All Urban Consumers, which is a similar inflationary measure to the CPI-W, showed big upticks in inflation for medical care services (4.9%), used cars and trucks (10.3%), and food (3.9%) over the unadjusted 12-month period ended in September.
For the third quarter of the previous year, the average CPI-W reading was 250.200. Comparatively, the average Q3 CPI-W reading for 2020 was 253.412. That's a year-over-year increase of 1.28%. Since COLA is rounded to the nearest tenth of a percent, it works out a 1.3% benefit increase for Social Security recipients. For context, this ties for the second-smallest positive COLA in history.
Based on estimates from the Social Security Administration, which assumes that the average retired worker will be receiving $1,523 a month by Dec. 2020, a 1.3% COLA works out to roughly $20 extra per month in 2021.
Not a lot to cheer about
On the bright side, any benefit hike is better than none at all. Considering how poor things looked five or six months ago, a 1.3% COLA is a victory for Social Security recipients.
However, there's probably not going to be a lot of cheering over one of the smallest year-on-year benefit hikes in history. Important expenditures to seniors, such as shelter and medical care services, have notably higher inflation rates than 1.3%. This implies that the purchasing power of Social Security income will decline again in 2021.
An analysis earlier this year from senior advocacy group The Senior Citizens League found that the purchasing power of Social Security income has declined by 30% between 2000 and 2020 for Social Security's retired workers. In short, what $100 in Social Security income used to buy in 2000 can now only purchase $70 worth of those same goods and services.
The fact is, the CPI-W isn't a very accurate measure of inflation for the Social Security program. As the CPI-W's official name implies, it tracks the spending habits of urban and clerical workers. These are typically working-age Americans who aren't receiving a Social Security benefit. As a result, those aforementioned important expenditures, like shelter and medical care services, are underweighted in the COLA calculation.
Until lawmakers address Social Security's CPI-W issue, seniors will likely continue to see their purchasing power dwindle more years than not.