By Jonathan Scheid, CFA, AIF®
Inflation has been the buzz word since the early stages of the COVID-19 pandemic. We all have experienced the frustration of rising prices whether from higher grocery bills, gas prices or virtually anything we want to purchase.
To help combat rising prices, workers typically receive increases in their paychecks. Of course, every company handles raises differently, and they may not offer them at all. For those not working and receiving Social Security checks, the Social Security Administration annually reviews the rate of inflation and adjusts the amount paid to beneficiaries. Because the administration calculates the cost-of-living adjustment (COLA) based on inflation, we believe this year retirees could see their monthly benefits increase by an estimated 8%-10%—the largest percentage increase since the early 1980s.
How is COLA calculated?
In mid-October of every year, the Social Security Administration reviews how much prices have changed from the year before, and it uses the information to change the COLA used to calculate the next year’s Social Security benefits. If there is no increase, there is no change in COLA.
When the administration calculates the adjustment, it doesn’t use the widely reported Consumer Price Index for All Urban Consumers (CPI-U, generally just referred to as CPI) or the Federal Reserve’s preferred measure of inflation, Personal Consumption Expenditures (PCE) Index. Instead, it uses the Consumer Price Index for All Urban Wage Earners and Clerical Workers (CPI-W). It’s an interesting choice since it doesn’t reflect the inflation experienced by the retired individuals receiving Social Security, but rather the inflation experienced by a subset of active workers still contributing to Social Security.
We won’t get into all the technical differences between the inflation measures, but the good thing is that CPI-U and CPI-W are typically not too far off. Consider last year’s COLA of 5.9%. It was similar to the CPI-U’s increase of 5.4% for the same time period, according to the Bureau of Labor Statistics.
|Year-Over-Year Percent Change In CPI-U And CPI-W Since October 2021|
To get an idea of what the annual increase to Social Security is going to be, we can look at recent reports of CPI-W. While the Social Security Administration uses the full third-quarter inflation for yearover- year comparisons, we’ll use a recent month. In the August 2022 report, CPI-W posted an 8.7% year-over-year increase in prices. A good portion of that increase occurred this year, so it is possible that the Social Security increase will be close to that level, but it could be higher or lower.
If the administration based the adjustment on August’s annual increase in prices, the current average monthly Social Security retirement benefit of $1,625 would increase to $1,766 starting in January of next year. That would lead to an average total of $21,192 paid to each beneficiary in 2023 compared with $19,500 in 2022—an extra $1,692 for the full calendar year.
Is it enough?
Given how quickly prices have increased, many people wonder if it will be enough to offset the higher prices we currently face. The inflation that everyone experiences is different. For some, an increase like we estimate above could be ample; for others it won’t suffice. This is where having a meaningful conversation with your financial advisor can be helpful. Your advisor can evaluate your personal situation and help you ensure you are on the right track or suggest course corrections to get you back in the right direction.
If you haven’t started receiving your Social Security retirement benefit yet, your advisor can also help you estimate your monthly payments and determine when the optimal time is to start receiving your benefits. Inflation adjustments benefit individuals that haven’t filed yet by increasing the starting benefit amount. In addition to inflation, the administration calculates your payments based on other factors, such as your earnings during your career, the age you started receiving benefits and your birth year.
Given the trends in inflation, it’s clear that Social Security benefits are going up next year to help retirees with higher prices. The Fed has also indicated it will continue to raise interest rates to bring down inflation. If inflation cools in the new year, we likely won’t be talking about the historically big increase in COLA next year. Instead, we may be talking about how it returned to the low levels of the last decade.
|Social Security Cost of Living Adjustments Since 1975|