Whether you're already retired or just entering the labor force, there's a high likelihood that Social Security will play an important role in helping you pay the bills during your golden years. When national pollster Gallup surveyed retirees and nonretirees earlier this year, 89% of current retirees said they lean on Social Security as a needed source of income (to some varied degree), while 84% of nonretirees expect to rely on Social Security in some capacity during retirement. 

Given these figures, it's no shock that Social Security's annual cost-of-living adjustment (COLA) is a much-awaited announcement.

A person counting a fanned pile of assorted cash bills in their hands.

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The CPI-W has determined cost-of-living adjustments (COLA) since 1975

Social Security's COLA is the benefit increase passed along most years that accounts for inflation. Since Social Security was designed with retired workers in mind, cost-of-living adjustments ensure that seniors can sustain their current standard of living and (ideally) purchase the same amount of goods and services year after year.

Prior to 1975, the program's COLA was something of a crapshoot. Between 1940, which is when retired worker payments began, and 1975, special legislative sessions of Congress approved 11 cost-of-living adjustments. These benefit boosts were completely arbitrary, with no COLA at all during the 1940s. This was followed by the largest COLA in history in 1950 -- a whopping 77%!

Thankfully, things have been a bit more predictable over the past 47 years. Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been Social Security's measure of annual price changes. If the aggregate price for a large predetermined basket of goods and services the CPI-W covers climbs from one year to the next -- note, only third-quarter CPI-W readings are used in the COLA calculation -- beneficiaries will receive a "raise" in the following year.

The 2023 Social Security COLA is going to be historic. However, it doesn't tell the full story.

An unusual "raise" awaits most Social Security beneficiaries in 2023

Following the release of September's inflation data by the Bureau of Labor Statistics (i.e., the last data point needed to calculate COLA for the following year), the Social Security Administration announced an 8.7% cost-of-living adjustment for 2023. This 8.7% "raise" is the largest on a percentage basis in 41 years. On a nominal-dollar basis, it's the biggest on record.

But there's a big difference between how much Social Security checks move up from one year to the next and how much of that increase beneficiaries get to keep. For example, the average retired worker is expected to receive an extra $146 each month next year. But with the cost of food, gasoline, electricity, medical care, shelter, and so on climbing, a considerable amount of this $146, or perhaps all of it, will go right back out the door as an expense. This is a very common occurrence.

However, something unusual is set to happen in 2023. For only the second time this century (2012 being the other exception), Medicare Part B monthly premiums will decline -- from $170.10 to $164.90. Medicare Part B is the segment responsible for outpatient care, and it's typically deducted directly from an individual's Social Security benefit each month. Lower-than-expected spending on Alzheimer's drug Aduhelm resulted in larger Supplemental Medical Insurance Trust Fund reserves, which is being passed onto Medicare Part B recipients in the form of lower monthly premiums next year.

This roughly 3% year-over-year decline might not sound like much, but it's a big deal considering that medical care inflation has predominantly outpaced Social Security's annual COLAs for decades. Thanks to Medicare Part B premiums falling in 2023, Social Security beneficiaries enrolled in Medicare will see a real-money "raise" (i.e., above and beyond the inflation rate) that allows them to keep more of next year's COLA.

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It's not all good news...

Considering the historically high inflation consumers have been dealing with this year, this unusual circumstance is a blessing. But don't count on this becoming the norm.

According to an analysis conducted by nonpartisan senior advocacy group The Senior Citizens League, the purchasing power of Social Security income has fallen by 40% since 2000. What $100 used to be able to buy in goods and services can now only purchase $60 worth of those same goods and services. In 2023, this purchasing power loss should shrink modestly. However, seniors are nowhere close to making up for the bulk of their lost purchasing power over the past 22 years.

The culprit for this mess is the CPI-W, which tracks the spending habits of "urban wage earners and clerical workers." In other words, people who aren't likely to be senior citizens or be receiving a Social Security check. Because the CPI-W does a terrible job of tracking inflation for the people who matter most (i.e., seniors), it doesn't provide enough weight for the most important expenses, such as medical care and shelter. This is what's resulted in the constant loss of purchasing power for beneficiaries.

With no clear path to switching out the CPI-W for a more accurate inflationary measure, I'm afraid the loss of purchasing power retirees have become accustomed to since the beginning of the century will likely recommence in 2024.