Your Social Security Raise: $0.70 per Day

Social Security just announced its 2013 Cost of Living increase. Thanks to an incredibly low rise in the official inflation benchmark, the typical retiree will see his or her payment increase a mere 1.7%. On average, payments to retirees are rising from $1,240 per month to $1,261 per month -- about $21 per month, or $0.70 per day.  

If you're scratching your head and wondering how exactly they figured your costs of standing still rose by a mere $0.70 per day over the past year, you're not alone. The unfortunate reality is that if you're a senior relying on Social Security, your costs of living probably did rise faster than that official level, since the benchmark they use doesn't really reflect seniors' costs.

Where the numbers go wrong
The government uses the "CPI-W" index to adjust Social Security payments. That index measures the impact of inflation on "Urban Wage Earners and Clerical Workers"  -- not retirees. There are two huge reasons that that number underestimates the real inflation rate for a typical retiree: health care and hedonic adjustments.

Health care: On average, the older you are, the more you spend on health care. What that means is that as you age, the amount you're anticipated to spend on health care goes up, regardless of the inflation rate. On top of that "natural" increase in costs you see due to aging, health care expenses have been rising faster than the overall inflation rate for decades. That combination means seniors are seeing big increases in an expense that affects them more than the folks modeled for the inflation calculation.

Hedonic adjustments: When the government calculates the CPI, it adjusts for changes in item quality over time and innovation through a statistical process that it calls "Hedonic quality adjustments." As a result, the out-of-pocket cash you shell out for something can actually go up, but the hedonic adjustment for quality improvements means that the item looks like a cost decrease to the CPI number.

As confusing as that seems, here's an example from the Bureau of Labor Statistics' (the folks who calculate the CPI) own website:

Source: U.S. Bureau of Labor Statistics.

As a result, the available replacement for a television that used to cost $250 will now run you a cool $1,250, but that heftier real world price tag actually looks like a 7.1% decrease to the CPI. It's more money out of your pocket to buy a television -- which is what you as a consumer feels -- but the CPI says more than 100% of that increase is driven by quality improvements, not inflation.

Those types of adjustments, which also hit clothing & typical household appliances, mean that your out-of-pocket spending could very well be rising faster than inflation, even if you're not buying more stuff. Sure, the quality may be better, but that's small comfort when the larger amount of cash you need to shell out for any given item means you've got all that much less to spend on everything else. It forces you to be more choosy and makes you feel poorer, even if the CPI says that statistically, you're not.

If that weren't bad enough...
Yet even though Social Security payments aren't enough to keep up with seniors' real costs of living, the program's Trust Fund is on a path to run out of cash around 2033, slashing benefits by about 25%. That's barely more than 20 years from now -- well within the expected lifespan of most of today's workforce and even some of the younger retirees currently collecting from the program.

With Social Security on the rocks, that leaves pensions and individual savings to make up the gap. But pensions are largely a dying breed, and there's something of a crisis when it comes to individuals saving on their own for their retirements. The stark reality that prospective retirees face is one where the social safety net is frayed and employers can largely no longer be counted on to reward their employees for a dedicated career of service.

The only lever left with any real chance of helping you through your retirement is your own investing, through 401(k)s, IRAs, and even plain old-fashioned investment accounts. It's not easy, and it takes decades of discipline to make it work, but the alternative is a truly gruesome retirement.