Whether you're already retired or just entering the labor force, the chances are high that you'll be reliant on Social Security income during your golden years. When national pollster Gallup surveyed retirees earlier this year, it found that 89% rely on their Social Security payout in some capacity to cover their expenses.
Social Security playing such a key financial role for seniors is why the annual cost-of-living adjustment (COLA) announcement during the second week of October is so important.
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How does Social Security's cost-of-living adjustment (COLA) affect you?
Social Security's COLA is the mechanism designed to ensure that nearly 66 million beneficiaries don't lose their purchasing power to the rising price of goods and services (inflation). If the costs of the goods and services recipients rely on rise by a certain percentage, ideally they'd like to see their monthly benefits increase by the same amount from one year to the next.
Prior to 1975, COLA was arbitrarily assigned by special legislative sessions on Capitol Hill (11 times in 35 years). Thankfully, things have been a bit more predictable since then. Over the past 47 years, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has served as Social Security's inflationary determinant.
The CPI-W has more than a half-dozen major spending categories and countless subcategories, each with their own respective weightings. These weightings let the Index be reported as a single number, which makes for clean-and-tidy comparisons to the previous month or year to quickly determine in which direction prices have headed.
To determine Social Security's cost-of-living adjustment for the upcoming year, you'd take the average CPI-W reading from the third quarter (Q3) of the current year (only July through September factor into the COLA calculation) and compare it to the average CPI-W reading from the same period in the previous year. If the current year reading surpasses the previous year, inflation has occurred, and the program's recipients are in line for a "raise." For some context, all but three of the past 47 years have resulted in a COLA for the following year.
The size of the "raise" amounts to the percentage increase in average Q3 CPI-W readings from one year to the next, rounded to the nearest tenth of a percent. You'll note that I've put "raise" in quotation marks. This is to signify that COLA is designed to match the prevailing inflation rate and won't actually help beneficiaries outpace it.
Historically high inflation will lead to eye-popping increases for Social Security checks in 2023. U.S. Inflation Rate data by YCharts.
Social Security checks are about to make history
Following what's seemed like more than a decade of minuscule cost-of-living adjustments (save for 2022), retirees are staring down a truly historic increase to their Social Security checks in 2023 -- and they have high inflation to thank for it.
With the U.S. inflation rate skyrocketing to a more than four-decade high in June, the rapidly rising costs for shelter, medical care, food, and energy are all playing a role in sending payouts noticeably higher for the program's beneficiaries in the upcoming year.
How high, you ask? According to the official statement from the Social Security Administration, the COLA for 2023 will come in at 8.7%. On a percentage basis, it's the biggest year-over-year increase in 41 years. But on a nominal-dollar basis, next year's increase to Social Security checks will be the largest on record by a mile.
Of course, it's one thing to tell nearly 66 million people they're getting a "raise" -- and an entirely different thing to demonstrate what an 8.7% COLA might actually look like in dollar terms for the average beneficiary. By December 2022, the Social Security Administration estimates monthly payouts for an assortment of beneficiaries will be as follows:
- Average retired worker: $1,681/month
- Average worker with disabilities: $1,364/month
- Average aged couple, both receiving benefits: $2,734/month
- Average widowed mother and two children: $3,238/month
- Average aged widow(er) with no children: $1,567/month
Here's what these same monthly Social Security checks will look like once the 2023 COLA takes effect in January:
- Average retired worker: $1,827 ($146/month increase)
- Average worker with disabilities: $1,483 ($119/month increase)
- Average aged couple, both receiving benefits: $2,972 ($238/month increase)
- Average widowed mother and two children: $3,520 ($282/month increase)
- Average aged widow(er) with no children: $1,704 ($137/month increase)
For a majority of recipients, a triple-digit monthly "raise" is on the way.
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Social Security's COLA has a downside, too
Superficially, an extra Benjamin Franklin (or three) in retirees' bank accounts each month will be a welcome sight. But dig a bit deeper into what's causing COLA to skyrocket, as well as the history of Social Security's cost-of-living adjustments, and you won't be nearly as happy.
To begin with, inflation is a double-edged sword. While historically high inflation will result in the biggest year-over-year percentage increase to benefits in 41 years, the expectation is that seniors will be forced to give a significant portion of this "raise" back due to the rising price of shelter, medical care, energy, and other expenses.
Retirees do benefit from a rare silver lining in 2023. Most Social Security beneficiaries aged 65 and over have their Medicare Part B premium automatically deducted each month. Part B covers outpatient services for eligible beneficiaries. Part B premiums rise almost every year but will actually fall by roughly 3%, from $170.10/month this year to $164.90/month in 2023. This reduction should allow retirees to retain more of their cost-of-living adjustment than usual.
Arguably, the bigger issue for Social Security recipients is that the program's COLA isn't doing what it was intended to do. In May, The Senior Citizens League, a nonpartisan senior advocacy group, estimated that Social Security income has lost an almost unfathomable 40% of its purchasing power since 2000.
The catalyst behind this drop in purchasing power is the CPI-W, which doesn't accurately measure the inflation that affects seniors (the primary beneficiaries of Social Security benefits). The issue is that the CPI-W tracks where "urban wage earners and clerical workers" are putting their money to work. These are usually working-age Americans who don't receive a Social Security benefit. More importantly, these are people who put their money to work very differently than seniors. The result is that key expenses for retirees (e.g., medical care) aren't being accurately weighted in the COLA calculation.
Without any significant changes to Social Security's inflationary tether, the expectation would be for this loss of purchasing power to continue.
