It’s important to understand the truth about Social Security cost-of-living adjustments.
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Social Security recipients receive a cost of living adjustment (COLA) in most years. Although this is often referred to as a raise, it is actually an adjustment to ensure that retirees don’t lose purchasing power due to inflation.
Seniors need to understand the truth about COLAs and what they can do for their finances. In particular, there are three things you need to know about how it’s calculated.
1. Social Security COLA is based on third quarter inflation data
The first thing to know is that COLA is calculated using third quarter data from the Bureau of Labor Statistics. Specifically, the Social Security COLA is based on the percentage increase in the average consumer price index for urban salaried and office workers (CPI-W) for the third quarter (July through September) compared to the average CPI-W for the same period last year.
Once the CPI-W data arrives, the Social Security Administration releases the COLA. The important months are July, August and September, so it is usually announced in October every year. However, this can be a problem because inflation can change.
If the third quarter CPI-W numbers show a 3% increase in the cost of living, your benefits will increase by 3%. However, inflation is likely to spike in October, November, and December because the COLA has already been calculated. Social Security was not adjusted because inflation worsened after the hike, and retirees could really struggle if high levels of inflation continue through 2027.
2. This may not be the most accurate measure of senior spending
The second thing to know is that CPI-W may not actually be the most accurate approach to determining how much to increase your profits. After all, the consumption habits of the elderly do not perfectly match those of urban salaried workers and office workers. As a result, the COLA formula typically underestimates how much seniors spend on certain things, such as medical expenses.
Unfortunately, areas where seniors tend to spend a lot, such as health care, tend to see more rapid price increases, so COLAs often end up with too small an adjustment. The National Federation of Senior Citizens estimates that retirees lost about 20% of their purchasing power between 2010 and 2024 because of this problem.
This knowledge is important for retirement planning, because you need to realize that Social Security won’t last as long in retirement if inflation eats away at your purchasing power. You need to have enough savings in your retirement plan to supplement your retirement savings.
3. COLA is not guaranteed, but your benefits will not be reduced.
Finally, the last thing to know is that annual adjustments to your benefits are not guaranteed. Your benefits will remain the same even if inflation data shows that prices have remained the same or that prices have fallen. But the good news is that once deflation occurs and prices start to fall, lose All benefits.
There were several years, including 2010, 2011 and 2016, when seniors did not receive Social Security adjustments. While inflation is currently high and such an outcome is unlikely to occur anytime soon, it could happen again in the future, so retirees need to prepare.
In reality, while you may think it’s bad to not receive benefit adjustments or receive only a small amount of benefits, many retirees are benefiting from lower inflation. So even if there is a year without a COLA, retirees could be better off if inflation remains low throughout that year. That’s because their retirement plans (which usually don’t have automatic inflation protection) don’t ultimately lose purchasing power due to rising prices.
Retirees should keep an eye on October’s COLA news to see how their income will change next year. But don’t expect this adjustment to significantly increase your purchasing power. This is not an actual price increase, as it is intended to help you maintain the value of your benefits when prices are increasing.
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