After months of being hammered by inflation, retirees have some relief on the way. The Social Security Administration (SSA) recently announced a benefits increase of 8.7%. It's the biggest "raise" for Social Security recipients in over 40 years.
But just how excited should seniors be about the upcoming cost-of-living adjustment (COLA)? Maybe not as much as you'd expect. Here's how much past Social Security increases have actually helped retirees.
Image source: Getty Images.
A mixed bag
SSA began determining annual COLAs in 1975. However, the adjustments were applied in June of each year through 1982. Beginning in 1983, the COLAs were effective in December with Social Security checks increasing in January of the following year.
We can determine how much a Social Security increase announced in a given year helped retirees by comparing it against the change in inflation during the subsequent year. The difference between the COLA and the inflation change in the next year provides a net effect of the adjustment. If the net effect is positive, the COLA was enough to more than offset inflation. If the net effect is negative, the COLA wasn't enough to offset inflation.
The following chart shows the historical Social Security COLA net effect by the year the adjustment was announced, beginning in 1983 and going through 2021. (Note: The inflation level for 2022 was estimated based on the first three quarters of the year.)
Data source: Social Security Administration. Chart by author.
During this period, there were 19 years when the COLA announced was more than enough to offset inflation in the subsequent year. However, there were 20 years when the COLA wasn't enough to offset inflation in the subsequent year. (You won't be able to see some of these on the chart because the negative effect was very small.)
Sometimes, the annual Social Security increase really helped retirees. For example, in 2008, the SSA announced a COLA of 5.8%. But in 2009, inflation declined by 0.67% as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) -- the metric used to calculate COLAs.
However, there were several years when the COLA wasn't nearly enough to protect Social Security benefits from being eroded by inflation. As a case in point, the COLA announced in 2020 (and that began showing up in retirees' benefit checks in 2021) was 1.3%. Inflation, though, rose nearly 5.3% in 2021.
It's likely that the net effect of Social Security COLAs for retirees could be even worse than what the above chart depicts. As previously mentioned, the SSA uses the CPI-W to measure inflation. However, this metric isn't designed to specifically evaluate the price changes incurred by seniors.
Another inflation metric called the Consumer Price Index for the Elderly (CPI-E) has been proposed for calculating COLAs. The CPI-E tends to increase at a faster rate than the CPI-W. This implies that inflation actually hits retirees harder than current Social Security COLA calculations estimate.
Looking on the bright side
I haven't intended to rain on retirees' parade after the celebration of a huge Social Security increase. But it's important to understand that the COLAs haven't been enough to preserve buying power throughout much of the past few decades.
Looking on the bright side, though, there are reasons for those receiving Social Security retirement benefits to be at least somewhat optimistic. For one thing, Medicare Part B premiums will be lower in 2023.
There's also a real possibility that inflation could moderate next year. The Federal Reserve is doggedly committed to raising interest rates with the goal of curbing inflation. Some experts predict that inflation will indeed fall in 2023.
Morningstar, for example, thinks that the combination of the Fed's moves and the resolution of supply chain issues will cause inflation to return to normal levels next year and beyond. If the financial services company is right, the net effect of the big Social Security COLA on the way for retirees should be quite positive.
