Happy New Year to all Social Security recipients. Some significant relief for your inflation-hit pocketbooks is on the way.
An 8.7% cost-of-living adjustment (COLA) is about to go into effect. There hasn't been a COLA that high since 1981.
Don't celebrate too much just yet. Social Security's biggest increase in decades has a serious problem.
Not enough and not soon enough
The Social Security Administration (SSA) implemented automatic annual COLAs in 1975 in an attempt to help solve a major issue. Social Security benefits were being eroded by inflation. It literally took an act of Congress to increase the amount of money that beneficiaries received.
The automatic annual COLAs helped, but they didn't actually solve the issue. Why not? The increases were not enough and didn't come soon enough.
Social Security COLAs are calculated using an inflation metric called the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The main drawback to the CPI-W is that it focuses on employed workers instead of retirees.
This is especially concerning because seniors spend much more on healthcare than younger individuals do — and healthcare costs are rising more quickly than other categories tracked by the CPI-W. As a result, annual COLAs often aren't enough to fully offset the impact of inflation on retirees.
The way that COLAs are calculated complicates the situation even more. Specifically, the average CPI-W in the third quarter of the current year is compared against the average CPI-W in the same quarter of the previous year. The COLA will equal the percentage increase (if any) from this comparison.
There are two key downsides to this approach. First, it's possible that inflation could be much higher in the first two quarters of a year than in the third quarter. Second, the COLA doesn't go into effect until December (and recipients don't see the increase until January). This means that seniors can incur significantly higher costs for a long time before they get an increase to offset these costs.
This year provides a great example of the not enough/not soon enough problem with Social Security COLAs. Retirees received a 5.9% benefit increase for 2022. But the inflation rate, as measured by the CPI-W, was 8.2% higher month over month in January, with the monthly increase rising to 9.8% by June.
The Senior Citizens League analyzed how effective this-year's COLA was in helping seniors. The organization determined that by the end of November, the average Social Security recipient's monthly benefit fell 46% short of keeping pace with inflation. So far in 2022, there hasn't been a single month where the 5.9% COLA was enough to offset the impact of inflation.
What's especially concerning is that The Senior Citizens League conducted a survey that found inflation appears to be pushing more older Americans into poverty. One-third of the survey recipients said that they have applied for food stamps or visited a food pantry over the previous 12 months, compared to 22% in 2020.
New year, same problem
Don't expect the fundamental flaw with the Social Security COLA to magically disappear in 2023. The new year will bring with it the same problem.
Retirees' increased Social Security benefits in 2023 will help offset some of the higher expenses they incurred in 2022. But they won't address any impact of inflation in the new year. While inflation does appear to be moderating somewhat, it could remain high over the near term. Unsurprisingly, a recent Motley Fool survey found that 55% of retirees don't think the 8.7% COLA will be enough.
If that's not troubling enough, there's potentially even more bad news for retirees with the latest Social Security raise. More retirees will have to pay federal income taxes on their Social Security benefits in 2023.
However, receiving a COLA is much better than not receiving one. Also, seniors can look forward to lower Medicare Part B premiums. Maybe 2023 won't be as happy of a new year as many would like, but it should be happier than it could have been.
Originally published on Fool.com
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