Social Security is often touted as a guaranteed, lifetime, inflation-protected income stream that retirees should milk for all it’s worth. While it does last a lifetime – and there are plenty of ways Congress might address the projected shortfall – the program probably won’t stand up to inflation the way many retirees hope it will.
Social Security’s Board of Trustees recently forecasted a 2.2 percent COLA for 2018 – by far the largest adjustment in the last few years and a seemingly significant improvement over 0.3 percent in 2017 and 0 percent in 2016. As the AARP pointed out, however, 2.2 is still a relatively small increase that will do little to nothing in the face of rising prices on health care and consumer goods.
Looking at the issue over a longer time horizon, it may not be wise to count on the COLA to preserve Social Security’s spending power for your clients. It’s a powerful income stream, no doubt, but given the health care crisis, rising food and energy costs and the ever-increasing longevity risk of today’s retirees, they’ll likely need an additional funding source in the future.
How the COLA is calculated today
Inflation protection wasn’t an original feature of Social Security; until 1975, Congress enacted every increase with special legislation. Since automatic annual COLAs began with the 1972 Social Security Amendments, rates have gone as high as 14.3 percent and as low as zero.
Where does the Social Security Administration get those numbers?
“The Bureau of Labor Statistics looks at how much the general cost of living expenses go up – not in the past year, but only in the third quarter of the past year,” says Gail Buckner, National Financial Planning Strategist with Franklin Templeton Investments.
The price fluctuations we see in July, August and September of each year, then, are reflected in beneficiaries’ checks in January of the following year.
“We had that zero percent increase in 2016 just because in the third quarter of 2015 there was a drop in specific prices – even though oil prices and everything else went up in the other three quarters,” adds Buckner.
The CPI-W and alternatives
More specifically, the COLA is tied to the third-quarter percentage increase in the CPI-W, the consumer price index for urban wage earners and clerical workers. The CPI-W prioritizes items purchased by metropolitan workers, including food, clothes, transportation and entertainment.
That metric is under fire for a couple of reasons. First, critics say it doesn’t reflect the true rate of inflation on the goods and services that impact consumers the most.
“They’ve redefined inflation in a way that shows it’s low,” says Bill Stack of Stack Financial Services. “What the government is looking at might go up 1 or 2 percent, but what everyone is really purchasing is going up a lot more than that.”
Second, even if the CPI-W did accurately reflect workers’ purchases, it doesn’t account for the costs that specifically impact retirees – namely housing and health care. Health care inflation alone has outpaced the CPI for over a decade, and while insurance premiums certainly reflect the increase, the COLA does not.