With inflation coming in at over 9% at the most recent reading, many retirees are concerned with how their Social Security benefits will hold up in this high-inflation environment. So I thought it would be a good idea to take a closer look at how the cost of living adjustment (COLA) is calculated for Social Security benefits.
Step #1 – Get the data
First, you’ll need the inflation data. There are a few different inflation data series published by the government, but Social Security COLA is based on one called Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W for short). You can find the historical index values on the Social Security Administration’s website.
Next, you’ll need to locate six data points. Social Security COLA is based on the change between the average value of CPI-W over the 3rd quarter (July, August, September) of the previous year and the current year.
For example, if we wanted to calculate the COLA for 2021, we would need the values for July, August, and September for both the year 2021 and 2020. And here they are:
Step #2 – Do the math
Using these values, we calculate the 3rd quarter average for each year, and then calculate the percentage change between those two averages.
But what about 2022?
Right now, we don’t have any of the data points from the 3rd quarter of 2022. The July data point won’t be available until August 10, 2022 and September won’t be available until October 13, 2022. But we can estimate the 2022 COLA using the data that we do have.
If we assume that there will be zero inflation between now and the end of September, then we can carry forward the most recent June data point and use it as the average value for 2022:
We could also assume that inflation over the next three months will match the average inflation rate for the first six months of 2022. In that case, we would get something like this:
My best guess is that the final numbers come in somewhere in the middle, or around 10%. It’s tough to say because there can be plenty of noise in the month data points. It’s also possible that inflation could reverse over the next few months and we end up with a COLA below 9%. But that strikes me as a low-probability outcome.
When does it take effect
The Social Security Administration will communicate the COLA amount in December 2022. You should receive a notice in the mail, but if not, you can always log in to your mySocialSecurity account here to retrieve the notice. The COLA will take effect for payments beginning in January 2023.
Social Security COLA… not too bad
This exercise offers a great reminder about the power of Social Security as a retirement tool. I doubt you will ever see any other retirement income vehicle offer this sort of COLA (except maybe with other government pensions such as for federal employees or military retirees).
Annuities, pensions, and long-term care insurance very often have zero inflation protection. And if they do, it’s unheard of to see a COLA exceed 10% per year. Most pensions or LTC insurance I’ve seen will cap inflation adjustments at between 3-5% per year.
Social Security is also guaranteed by the US Government. And if you think Uncle Sam has too much debt, just remember he’s way less risky than most corporations, unions, or state/municipal governments.
If you have already claimed Social Security, enjoy your (hopefully) giant COLA this year. If you have yet to claim Social Security, consider delaying as long as possible. Your benefit will grow until you turn age 70. And those larger benefit checks get full coverage under Social Security COLA rules, which can provide much needed support should you or your spouse live into your 90s or beyond.
