In September, the more than 48 million retired workers currently receiving a Social Security benefit brought home about $1,674 for the month. This may not sound like a lot, but based on a survey conducted by national pollster Gallup earlier this year, it's a necessary source of income for nearly 90% of seniors receiving Social Security.
For the many people who have come to lean on Social Security income to help pay their expenses during retirement, the annual cost-of-living adjustment (COLA) is pretty much the most anticipated announcement of the year.
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Social Security's cost-of-living adjustment helps beneficiaries keep pace with inflation
COLA represents the payout increase recipients get most years to account for inflation. If prices go up for the items Social Security beneficiaries buy, their benefits should climb to match this increase (at least in an ideal world).
For the past 47 years, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been the program's COLA determinant. As I've previously detailed, the CPI-W has eight large spending categories and a multitude of subcategories, all of which have their own respective percentage weightings. These are important because it allows the CPI-W to be expressed as a single number, which can then be easily compared to the prior-year period to determine if prices are rising or falling for a large basket of goods and services.
Although some aspects of Social Security can be intimidating or hard to understand, calculating the program's COLA is actually very simple. If the average CPI-W reading from the current third quarter -- that's July through September -- is higher than the comparable period from the previous year, inflation has occurred and Social Security recipients get a "raise" in the upcoming year. Just keep in mind, this is a "raise" designed to match inflation and not outpace it, which is why I have "raise" in quotation marks.
The year-over-year percentage difference in average third-quarter CPI-W readings, rounded to the nearest tenth of a percent, determines how large the COLA is for the following year.
Rapidly rising inflation has spurred a large Social Security COLA in 2023. U.S. Inflation Rate data by YCharts.
Next year's COLA is historic in a variety of ways
In 2023, retirees, disabled workers, and survivor beneficiaries are going to enjoy a historic monthly payout increase. As reported by the Social Security Administration during the second week of October, next year's cost-of-living adjustment came in at 8.7%. On a percentage basis, it's the largest increase in monthly checks since 1982. Meanwhile, on a nominal-dollar basis, it'll represent the largest year-over-year jump on record.
What does this mean on a dollar basis? For the aforementioned 48 million-plus retired workers, an average monthly payout increase of $146 is on the way in 2023.
The reason for this mammoth bump in Social Security payouts has to do with a more than four-decade high for the prevailing inflation rate. In June, the yearly change in the U.S. inflation rate hit a jaw-dropping 9.1%. Though the year-over-year change fell ever so slightly from this 9.1% rate between July and September (the months used for the COLA calculation), it remains far above historic norms -- thus the multidecade high for 2023's cost-of-living adjustment.
To be a bit more specific, energy, food, and shelter expenses have been primarily responsible for driving the inflation rate higher. According to data released by the U.S. Bureau of Labor Statistics for September 2022, the year-over-year change in energy prices, which includes all types of fuel, utility service, and electricity, was close to 20%, based on the CPI for All Urban Consumers (CPI-U). The CPI-U is a similar inflationary measure to the CPI-W. Meanwhile, food and shelter costs respectively rose by 11.2% and 6.6% from the prior-year period.
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Brace for impact: There may not be a Social Security COLA in 2024
However, beneficiaries should enjoy this sizable payout bump while it lasts, because there's a very real possibility that 2024 could result in a 0% cost-of-living adjustment for the fourth time in a 15-year stretch.
With the prevailing inflation rate soaring, the Federal Reserve has had little choice but to aggressively increase interest rates to slow borrowing and shift wage power away from workers and back to businesses. To be blunt, the nation's central bank is pumping the brakes on the U.S. economy to keep inflation from causing further damage. It's a necessary step, but one that could prove painful to Social Security beneficiaries come 2024.
The last time we witnessed the U.S. enter a true recession -- not the two-month swoon caused by the COVID-19 pandemic in 2020 -- was December 2007 through June 2009. This was a period marked by a brief spike in energy commodity prices, and then an absolute tumble in virtually all commodities as U.S. economic growth tapered off. In 2009 and 2010, the average third-quarter CPI-W reading declined from the prior-year period, which resulted in no COLA being issued in 2010 and 2011.
Although the dynamics of the Great Recession more than a decade ago are certainly different than the headwinds the U.S. economy is contending with now, the probability of the U.S. entering a recession within the next year has grown significantly in recent months. If that were to happen, there's a good likelihood that the key contributors to year-over-year inflation would see price declines in 2023. In short, the average third-quarter CPI-W reading in 2023 might come in below the comparable period in 2022 and result in 0% COLA for 2024.
Admittedly, this is a very early prognostication. At this time last year, virtually no one was predicting that the inflation rate would top 9% by mid-year, or that the Fed would have increased its federal funds target rate by 375 basis points in less than a year. Nevertheless, the telltale signs are present that the 2024 Social Security COLA could disappoint.
