Earlier this month the Social Security Administration (SSA) announced an 8.7% increase in 2023 benefits. On the surface, this appears to be great news, considering how rampantly inflation has been eating into purchasing power, especially for our most vulnerable population.

I'm not here to take the wind out of anyone's sails. I do believe it's a good thing that the SSA is raising benefits. However, the underlying implications of the increase have me a little less enthusiastic. Let's explore why.

Person looking nervously into the distance.

Image source: Getty Images.

Large COLAs occur when inflation soars

It's important to understand why the SSA implements cost-of-living adjustments (COLAs). These year-over-year benefit changes are designed to protect a senior citizen's purchasing power against inflation.

The SSA compares the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) data from the third quarter of the current year to the third quarter of the previous year to calculate the percentage increase. While a large increase in benefits may feel like a gift, it only occurs when your purchasing power is eroding at an alarming rate.

It's great that the SSA takes this into account, but it's important to understand that COLAs don't give seniors any additional purchasing power. They simply aim to protect them from losing it.

The increase might not be enough

This leads me to my second point, which is that this latest COLA might not even achieve its primary goal of protecting purchasing power. While inflation has been steadily rising all year, there was actually a slight dip in August.

Blocks of woods spelling out Cost of Living.

Image source: Getty Images.

Pundits were initially optimistic about this, but the enthusiasm has been relatively short-lived as it appears the inflationary easing has more to do with a temporary slowdown in gas prices than a broader-based cooling off in prices.

It's unfortunate that this dip occurred in the third quarter because that's the only quarter the SSA looks at to determine the next COLA. In other words, inflation could still be accelerating, but because it temporarily cooled down in August, the 2023 Social Security COLA is likely lagging true inflation.

This can be seen in the Federal Reserve's comments at the September Federal Open Market Committee (FOMC) meeting: "The war [in Ukraine] and related events are creating additional upward pressure on inflation and are weighing on global economic activity."

If inflation continues to rise as the Federal Reserve anticipates, Social Security beneficiaries could see their purchasing power erode, even with the 8.7% COLA.

This bump puts more pressure on Social Security's solvency

Finally, the latest COLA could have adverse effects on the future of the Social Security program. When the SSA receives more revenue than is needed to pay the current-year's benefits, it places the extra cash in two trust funds that invest in Treasury bonds to increase the program's reserves. In June, the SSA released its annual report on the status of the program's trust funds. The report stated the program is facing "long-term financing shortfalls," and at the current rate, the trust funds only have enough to supply benefits through 2034.

This report was released well before the 2023 COLA announcement, so it's possible that the insolvency date could now come even sooner.

With rising interest rates, the investments in the trust will produce higher yields that could balance out the COLA. But recent comments from the Committee for a Responsible Federal Budget, a non-profit public policy organization in D.C., are less than optimistic:

This very large COLA increase is likely to bring the year of insolvency forward by a full year. It is just another reminder that procrastinating on addressing these imbalances leaves the people who depend on Social Security particularly vulnerable to a further deterioration in its finances.

It's not all gloom and doom

At the heart of every COLA is a problem: inflation. And if inflation continues to rise, Social Security recipients will see their overall purchasing power diminish in the coming year.

There is hope in the recent Federal Reserve comments that a good chunk of the inflationary pressure can be attributed to relatively short-term events -- the war in Ukraine and the COVID-19 pandemic.

If the supply chain challenges derived from these events are resolved in the near future, which is quite possible, we could see a dramatic decrease in inflation. This would provide some much-needed relief for Social Security beneficiaries.