The 2023 Social Security COLA Forecast Is Great News for Retirees. Here's the Real Reason Why.

High inflation has rocked the U.S. economy this year, sparking a stock market implosion that has erased more than $3 trillion from retirement accounts. Meanwhile, millions of Americans have been forced to tap into savings to cover the rising cost of gas, groceries, and monthly bills. But the impact of inflation has been especially profound for seniors who depend on monthly Social Security checks.

Beneficiaries have battled rising prices at every turn. Medicare Part B premiums soared 14.5% this year, one of the largest price hikes in history, and seniors have been forced to spend more on necessities like electricity, natural gas, and home heating oil, all of which logged double-digit price increases in August.

That means the 5.9% cost-of-living adjustment (COLA) applied to Social Security benefits in 2022 significantly underestimated the trajectory of inflation. In fact, the 2022 COLA has fallen short by 48% through August, according to The Senior Citizens League (TSCL), meaning the average beneficiary has been shortchanged $417 year to date.

Fortunately, Social Security beneficiaries may catch a break next year. The 2023 COLA is on pace to hit a four-decade high of 8.7%, according to TSCL. That means the average retired worker could see an extra $146 per month in benefits, but there is another reason an 8.7% COLA would be great news for seniors.

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A flaw in the way Social Security COLAs are calculated

Inflation erodes the buying power of money, but COLAs are designed to offset that force by ensuring Social Security benefits keep up with rising prices. Many experts argue the system has failed, citing a critical flaw in the way COLAs are calculated. In fact, TSCL says Social Security benefits have actually lost 40% of their buying power in the last two decades.

Social Security COLAs are based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a metric that tracks how much more (or less) office workers and other wage earners must pay for the same basket of goods and services over time. Put another way, the CPI-W is based on purchases made by working-age individuals. But the spending patterns of workers are a poor approximation for the spending patterns of seniors.

For instance, the CPI-W tends to underemphasize relevant spending categories like medical care, prescription drugs, and housing. It also tends to overemphasize spending categories that are less relevant to seniors such as education, apparel, and transportation. To that end, experts argue COLAs should be based on the Consumer Price Index for the Elderly (CPI-E), a metric based on purchases made by individuals 62 years of age and older.

How big is the impact? The CPI-E regularly puts inflation two-tenths of a percentage point higher than the CPI-W, according to TSCL, and compounding makes that discrepancy quite significant over time. For instance, seniors would have received an extra $5,800 in benefits over the last two decades if COLAs were based on the CPI-E.

Social Security benefits may reclaim some lost buying power in 2023

However, something odd has happened this year. Inflation as measured by the CPI-W has actually outpaced inflation as measured by the CPI-E. The exact figures are shown in the chart below.

Data sources: Bureau of Labor Statistics, Social Security Administration. Note: inflation figures reflect year-over-year changes in the CPI-W and the CPI-E.

Based on the data above, the CPI-W -- the metric used to calculate Social Security COLAs -- has actually overestimated the impact of inflation on seniors this year. To that end, an 8.7% COLA in 2023 would more than offset rising costs incurred by seniors in 2022, meaning Social Security benefits could reclaim some of the buying power lost over the last two decades.

As a caveat, the official COLA in 2023 cannot be calculated until the Bureau of Labor Statistics releases its September inflation report on Oct. 13. That means the actual COLA applied to benefits next year could be a little more or a little less than 8.7%. But based on the discrepancy between the CPI-W and CPI-E throughout the year, odds are the COLA in 2023 will be great news for seniors on Social Security.