After seeing some of the highest levels of inflation in more than four decades last year, Social Security benefits increased by a whopping 8.7% this year thanks to the program's annual cost-of-living adjustment (COLA).
The adjustment was big for retirees, who have seen their purchasing power eroded more than usual over the past few years because of surging inflation. While they are still dealing with high consumer prices, the chance for another big COLA in 2024 like that seen this year is getting slimmer by the month. Here's why.
How the COLA is calculated
The Social Security Administration (SSA) calculates the following year's COLA based on the current year's inflation. Specifically, the SSA uses inflation data from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which tracks the prices on a market basket of consumer goods and services that are typically purchased by that group of the population.
Image source: Getty Images.
The SSA looks at the CPI-W for the months of July, August, and September. It then averages the CPI-W during these three months and compares it to the average CPI-W for the same three months of the prior year. The percentage difference between these two numbers equals the following year's COLA, although a COLA can never be negative for Social Security.
Due to the Federal Reserve's aggressive interest rate hikes over the last year, inflation has started to slow down. It peaked at about 9% in the middle of 2022, but in January 2023, the CPI-W was up about 6.25% year over year. In February, the CPI-W eased again, and was up about 5.8% year over year.
I would expect inflation to keep coming down as the year progresses because all of the Fed's rate hikes have not worked their way through the economy yet, and we also know the Fed's preferred rate of inflation is 2%, so it is still too high. The Fed has also continued to raise interest rates this year, and another rate hike could be coming at the Fed's May meeting.
While it's hard to say precisely, the International Monetary Fund in February projected that the annual inflation rate in the U.S. would drop to 3.5% by the end of the year.
Meanwhile, financial publisher Kiplinger projects annual inflation to drop to 4% by the end of 2023, and consumers' one-year inflation expectations recently dropped to 3.8% in March, according to a regular survey conducted by the University of Michigan.
A glass half full
Thinking about where the CPI-W was in February and projections for inflation by the end of the year, there is a good chance the CPI-W numbers could come down to between 3.5% and 5% in the third quarter of the year.
This is just a guess, and inflation could also drop much further. That means the COLA for 2024 could be somewhere in the 4% to 5% range or even lower, which is a far cry from last year's 8.7% raise.
However, historically speaking, a 4% or 5% COLA would not be bad at all, so retirees could still get a somewhat decent raise next year. We'll just have to wait and see.
