Retirees will learn in mid-October how much their Social Security benefits will increase next year. Whatever the amount is, many will feel like it's not enough. And they'll probably be right.
It's no secret that the way the Social Security Administration (SSA) calculates cost-of-living adjustments (COLAs) doesn't reflect the increased costs for older Americans as well as it should. However, Social Security's COLA calculation is especially bad for roughly 20% of retirees.
Image source: Getty Images.
The key metric used in Social Security COLAs
To understand the issue, we must first examine how Social Security COLAs are calculated. The annual COLA is intended to prevent Social Security benefits from being eroded by inflation. But the way the SSA measures inflation isn't the inflation metric you'll hear about on the news.
Each month when the U.S. Bureau of Labor Statistics releases the latest inflation numbers, the Consumer Price Index (CPI) receives the most attention. For example, if you hear that the inflation rate was a certain percentage, they're referring to the CPI.
However, SSA uses a different inflation metric to calculate the Social Security COLA. It's the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W measures the costs of over 200 goods and services for families living in urban areas with more than half of the family's income earned from clerical or hourly wage jobs.
The big problem for around 20% of retirees
No inflation metric is perfect. However, the CPI-W presents an especially significant issue for many retirees because it focuses only on individuals living in urban areas. Why is this problematic? Inflation has been hitting people in rural areas harder than those living in urban areas.
A detailed analysis performed by economists with the New York Federal Reserve Bank found that "rural households experienced considerably higher inflation than urban households did" in recent years. There's a straightforward reason why this is the case. People in rural areas tend to drive more and are therefore more negatively impacted by higher fuel prices.
Based on the 2020 U.S. Census, 20% of Americans live in rural areas. However, there's good reason to believe that even more retirees live in rural rather than urban areas.
Between 2012 and 2016, 22.9% of individuals aged 65 and older lived in rural areas, according to the U.S. Census Bureau. A study conducted last year found that retirees continue to move from more highly populated states to more rural states.
Is the Social Security COLA calculation working against you?
If you're one of the at least 20% of retirees living in rural America, the CPI-W metric used to calculate Social Security COLAs probably doesn't fully reflect the higher costs you're paying. However, even if you live in an urban area, the Social Security COLA calculation is still likely working against you.
The main issue is that the CPI-W isn't designed to capture the costs incurred by seniors. In particular, it doesn't give a high enough weight to healthcare expenses. Inflation numbers for May underscore this problem. While the CPI-W rose 3.3% year over year, hospital services costs soared 7.2%.
What can retirees do? Most importantly, you can closely watch your spending with the understanding that the annual Social Security COLA probably won't fully cover your higher costs.
You can also contact your congressional representatives to encourage them to support replacing the CPI-W with another inflation metric that better measures retirees' costs called the Consumer Price Index for the Elderly (CPI-E). The CPI-E isn't perfect, either, but could better reflect your costs.
As for retirees living in rural areas, the good news is that your overall costs of living are likely lower than they'd be if you lived in an urban area. It's also possible that the trends of higher inflation in rural areas compared to urban areas will reverse over time.
