Social Security benefits have fallen behind inflation this year, leaving many retired Americans in a difficult position. In fact, more than seven in 10 retirees rank rising prices as their biggest financial concern right now, according to Goldman Sachs.
Fortunately, Social Security benefits are adjusted for inflation on an annual basis, and recipients will get a historic 8.7% cost-of-living adjustment (COLA) in 2023. That is largest COLA enacted in more than four decades and the fourth-largest COLA in history. Generally speaking, that is a positive development for retired workers, though there are a few caveats.
Here's the good, the bad, and the ugly news related to Social Security's 2023 COLA.
Image source: Getty Images.
The good news: A bigger Social Security benefit will help retirees fight inflation
Social Security COLAs are based on third-quarter changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a metric often used to measure inflation. The CPI-W increased 5.9% in the third quarter of 2021, so Social Security benefits got a 5.9% adjustment in 2022.
Unfortunately, inflation continued to accelerate after the 2022 COLA was finalized, meaning rising prices have chewed away at the buying power of benefits this year. The table below shows the trajectory of inflation over the last five quarters.
|
Time Period |
Inflation Rate (Change in CPI-W) |
|---|---|
|
Q3 2021 |
5.9% |
|
Q4 2021 |
7.4% |
|
Q1 2022 |
8.7% |
|
Q2 2022 |
9.3% |
|
Q3 2022 |
8.7% |
Data source: U.S Bureau of Labor Statistics.
Year to date, the CPI-W has climbed 8.9% compared to last year. That means the 2022 COLA needed to be a full three percentage points higher to fully protect the buying power of Social Security benefits. In a nutshell, the COLA enacted this year underestimated the impact of inflation.
Fortunately, inflation has slowed in recent months as the Federal Reserve has taken aggressive action to rein in rising prices. Assuming that trend continues, the 8.7% COLA in 2023 may overestimate the impact of inflation, leaving beneficiaries with a little extra cash. That should help retired workers cover the elevated cost of food, gas, and monthly utilities, though the extent of that silver lining depends entirely on where inflation goes over the next year.
The bad news: More retirees will owe taxes on Social Security benefits
Social Security benefits were exempt from federal income tax for many decades, but that changed with legislation in 1983. At first, beneficiaries with a modified adjusted gross income (MAGI) of $25,000 for single filers or $32,000 for joint filers had to pay tax on up to 50% of benefits. But a decade later, another piece of legislation added a higher threshold, establishing that beneficiaries with a MAGI above $34,000 for single filers or $44,000 for joint filers had to pay tax on up to 85% of benefits.
Initially, less than 10% of beneficiaries met the lower threshold, but that figure sits above 50% today, according to the Social Security Administration. Why? Simply because those tax thresholds have never been adjusted for inflation, so each COLA enacted since 1983 has pushed more people above the income limit. That means a massive COLA in 2023 will leave some beneficiaries with a bigger tax bill in 2024.
The ugly news: The Social Security trust fund may be depleted more quickly
The aging population has put the Social Security program in hot water. Last year, costs exceeded income by $56 billion, and that trend will continue indefinitely, setting the Social Security trust fund on pace to be depleted by 2035, according to the board of trustees.
Of course, that depletion date is only an estimate, and it is based on a great many assumptions. So the board of trustees actually modeled three different scenarios -- one high cost, one low cost, and one intermediate -- to compensate for error. Those three scenarios put the trust fund depletion date at some point between 2031 and 2069, but none of the scenarios accounted for an 8.7% COLA.
The board of trustees estimated the 2023 COLA would land between 3.92% and 5.14%. That means Social Security benefits will rise more sharply than anticipated next year, which could accelerate the depletion of the trust fund.
On the bright side, government officials still have time to solve that problem. And even if the Social Security trust fund does run dry, payroll tax will still cover 80% of scheduled benefits in 2035.
