The majority of Americans are worried about future Social Security benefits cuts, with close to six in 10 Americans afraid benefits won't be there for them.
But while future cuts are a real possibility, many have missed the fact that de facto cuts have actually already occurred. In fact, benefits are effectively around 30% smaller today than they were in the year 2000 -- and things are only going to get worse.
Social Security benefit cuts have already happened
Most Americans don't know that Social Security benefits have effectively been cut not because of any legislation or changes in the rules. Instead, benefits have seen a reduction in their value because of the way that cost-of-living adjustments (COLAs) are calculated.
Cost-of-living adjustments were built into Social Security to make sure benefits didn't lose buying power as a result of inflation. Unfortunately, the process by which this occurs doesn't really ensure seniors actually see the benefits increases they need for their retirement checks to retain their value. That's because the process by which raises occur uses something called CPI-W to determine how much benefits should go up from one year to the next.
CPI-W is short for Consumer Price Index for Urban Wage Earners and Clerical Workers. CPI-W gives more weight to some categories of spending rather than others in determining how much prices are rising. And it understandably does this based on the spending patterns of urban wage earners and clerical workers, as its name suggests.
The problem comes because seniors don't spend in the same way that these two demographic groups do. Seniors spend more on housing and healthcare and less on things such as transportation, entertainment, and child care. And the categories where seniors tend to spend heavily tend to face much higher inflation, which isn't accurately measured by CPI-W.
The result of this is that research from Senior Citizens League shows Social Security benefits have lost about 30% of their buying power since 2000. And each year when retirees get small cost-of-living adjustments due to CPI-W not showing much of a change in prices, retirees will lose more ground.
Unfortunately, 2021 is one of those years. For a long time, it didn't look like there'd be any Social Security benefits increase next year at all because COLAs are based on year-over-year changes to CPI-W that occur during the third quarter of the year. When prices go down or stay the same in July, August and September, there's no COLA. And with COVID cases spiking and causing a drop in demand for consumer goods during the early summer, it seemed this might happen this year.
Ultimately, however, higher inflation in the later half of the summer meant that there will be a raise after all. But retirees will see their benefits rise by only 1.3% next year. This is the smallest COLA since 2017, with the average senior getting less than $20 per month more in Social Security benefits.
This small raise will occur at a time when housing prices are reaching record highs and when medical costs are rising rapidly. And unfortunately, evidence also suggests changes in consumer-spending patterns driven by the pandemic have affected the accuracy of consumer price indexes as a measure of inflation, resulting in official data showing the cost of living rising more slowly than it actually is.
For both current and future retirees, a small COLA that underestimates rising prices will only serve to accelerate the slow, steady decline in Social Security's buying power. This de facto Social Security cut has real consequences, as current retirees may need to tighten their budget to avoid having to increase retirement account withdrawals or go into debt to maintain their standard of living. And future retirees may need to save more for the future to ensure they don't over-rely on Social Security benefits that are worth less every year.