One little-known but extremely valuable aspect of Social Security is that the benefits that it pays out are adjusted for inflation. That means that throughout the course of your retirement years, you can anticipate that your monthly Social Security check will rise gradually in order to keep up with the rising cost of living and help you sustain the purchasing power of your benefits. However, as some Social Security recipients learned for the first time this year, Social Security payments don't always go up. Below, we'll look more closely at what causes benefits to rise and why you can't count on getting a raise every single year.
How Social Security determines cost-of-living adjustments
The laws that govern Social Security set forth a specific formula that the program must use in determining the amount by which benefits will rise every year. The formula uses figures on the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W for short. These figures are available every month from the Bureau of Labor Statistics.
Specifically, what Social Security does it look at the CPI-W figures for the months of July, August, and September. It takes the average of the CPI-W over those three months and then compares it to the corresponding average for the previous year. If the current year's average is higher, then Social Security calculates the percentage increase, and that becomes the cost-of-living adjustment for benefits for the following year. For instance, in 2014, the average for those three months was 234.242. That was up from the average of 230.327 in 2013. Therefore, the increase of 1.7% became the COLA that took effect at the beginning of 2015.
Why you don't always get a Social Security increase
Typically, inflation is positive, and so during most years, Social Security recipients get a payment increase. Occasionally, however, prices turn downward for a brief interval. Last year, for instance, the three-month average for the CPI-W was 233.278, which was less than 2014's 234.242 figure.
Social Security never adjusts benefits downward, because it understands the impact that a pay cut could have on retiree finances. So if the formula produces a negative result, Social Security simply keeps payments unchanged for that year. That was the case for the 2015 determination that took effect at the beginning of 2016.
However, one thing to keep in mind is that the negative adjustment doesn't just disappear forever. Instead, Social Security continues to use the average CPI-W figure that corresponds to the last time a cost-of-living adjustment was made. Therefore, the average this year for CPI-W will need to exceed 2014's 234.242 in order for there to be a cost-of-living adjustment to take effect in 2017. Given that the latest available reading for the CPI-W was 233.438 as of April, inflation will need to pick up fairly dramatically in the coming months in order for Social Security recipients to get a cost-of-living increase next year.
Are changes coming?
Angered by the disparity between the inflation figures used to determine cost-of-living adjustments and their own personal experience, many retirees have called on lawmakers to change the way they measure inflation. Use of the Bureau of Labor Statistics' experimental inflation index geared toward spending patterns among senior citizens, known as the CPI-E index, could lead to a closer match between how Social Security measures price increases and the actual costs that retirees bear.
Others have suggested that regardless of how inflation gets measured, Social Security should have a minimum cost-of-living increase that takes effect even if inflation is flat or down in a given year. However, with Social Security already facing long-term financial pressures, it's uncertain whether there's enough political will in Washington to push such reforms forward, especially on a permanent basis.
Regardless of the eventual outcome over the long run, quick changes are unlikely to occur anytime soon. As a result, Social Security recipients will have to watch the inflation data over the next several months very closely to see if there's any major change to the prospects for a cost-of-living increase for 2017. If the figures produce another year with no increase to Social Security benefits, the result could be an even louder uproar calling for action on Capitol Hill.