The inflation monster has risen with a vengeance these past two years! After some decades of minimal or no increase in year-over-year prices, we are suddenly experiencing inflation the likes of which we haven’t seen since the 1980s.
So, this an excellent opportunity to examine how changing prices impact our Social Security. We’ll look a bit at the mechanics of the price adjustment and then consider why our annual Cost of Living Adjustment (COLA) with Social Security makes our benefits especially valuable in times of rising prices.
What is the Social Security Cost of Living Adjustment?
The COLA is the mechanism by which the Social Security Administration ensures that your Social Security benefits continue to be worth the same amount to you, in real spending terms, year after year.
If we look at the COLAs for the 12 years ending in 2020, the average increase was just under 1.4%. In fact, for three of those 12 years the increase was zero! Actually, prices fell slightly during those years. However, Social Security never reduces our benefits for deflation, they just apply a 0% COLA.
In sharp contrast to this long-term trend, the 2021 COLA (applies to benefit payments in 2022) leapt to 5.9%, according to the Bureau of Labor Statistics—they determine the Consumer Price Index (CPI)! The current COLA estimate for 2022 is 8.7%, though that will be revised depending on the September CPI number which will be released in mid-October. (The COLA is determined by the change in this year’s third quarter CPI in comparison with the prior year’s third quarter CPI.)
What the Media Gets Wrong About the COLA
In times like these we tend to see two different types of headlines for articles about the COLA. Some read, “Social Security Recipients to Receive the Biggest Raise in Years!” The others: “Social Security COLA will Fail to Keep up with Retiree Expenses!”. Neither is accurate—though I suppose they succeed in getting readers, seniors especially, to open and read the articles.
The COLA is not a raise; never has been. The purpose of the COLA is to approximately keep the purchasing power of our benefits constant over the years of our retirement, no more, no less. As to the argument that the COLA is sufficient to keep up with the expenses of retirees, again, that’s not its intent: the purpose is to keep up with the original purchasing power.
Clearly the mix of retiree expenses varies over time: many retirees travel and entertain more earlier in retirement, while spending relatively more on healthcare and personal assistance later in retirement. Also, spending is individual, depending on the health and general interests at any point in time. In short, we cannot customize the COLA for each individual, so of necessity some will benefit more from it in any given year while others will not.
What Does This Mean for You?
Here's what’s critically important (and to repeat an earlier point): the Social Security COLA keeps the purchasing power of our benefits relatively constant over what can be decades of our retirement. Few pensions and no simple annuities are inflation-adjusted. Thus, in a year like this one, most pensions and simple annuities would lose purchasing power by 8%-9%, not just this year, but for every year thereafter. Several years of high inflation can do severe damage to the value of most pensions and all simple annuities.
For instance, if inflation averaged 4% over 20 years of a retirement, most pensions and all simple annuities would lose over half their purchasing power, whereas Social Security would retain approximately the original purchasing power. That’s a huge difference, especially at a point in our retirement where we are in our mid-80s: That’s a time when we cannot do much about our financial situation but worry.
Social Security and its annual COLA are a benefit guaranteed by the federal government. In a time of rising inflation and falling prices of stocks and most other assets, this guarantee should be a source of comfort to current and future Social Security beneficiaries.