For many Americans, this has been one of the most challenging years of their lives. The coronavirus pandemic has completely changed our social norms, costing more than 20 million people their jobs, and sent the U.S. economy into its steepest recession in history.
Although retired workers are unlikely to be hit as hard – financially – by the pandemic as working Americans, there are still concerns about how it could negatively impact the cost of Social Security housing in the coming year. With the first of three key data points released last week, it looks like 2021 COLA of Social Security offers a good news / bad scenario for more than 64 million beneficiaries of the program.
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A step by step guide of how COLA of Social Security is calculated
However, before going into the specifications, it is important to understand how the COLA of Social Security is calculated each year.
Since 1975, the Consumer Price Index for Urban Wage Representatives and Clergy Workers (CPI-W) has served as the inflationary tether of Social Security. The CPI-W follows the price movements of a predetermined basket of goods and services, and ultimately helps the Social Security Administration determine how much of an “increase” its tens of millions of companions will receive in the next year to promote inflation.
But not every month factors in the COLA calculation of Social Security. The only CPI-W readings that matter are in the third quarter (July to September). Although the U.S. Bureau of Labor Statistics (BLS) reports CPI-W readings every month, the other nine months of the year are simply used to identify trends.
To determine the COLA of Social Security for the following year, the average CPI-W reading of the third quarter of the current year is compared with the average CPI-W reading of the third quarter of the previous year. If this figure has increased from one year to the next, inflation has occurred, and recipients will receive an increase. The amount is simply the increase in the year-over-year percentage in average Q3 CPI-W readings, rounded to the nearest tenth of a percent.
In 42 of the past 45 years, the average quarterly CPI-W reading has increased from one year to the next, indicating inflation and an increase for Social Security recipients. In the other three years (2009, 2010, and 2015), deflation occurred, which meant that benefits remained flat in the following year (2010, 2011, and 2016). Social security benefits may not decrease due to deflation.
Now that you have a better idea of how the COLA of Social Security is calculated, let’s move on to the meat and potatoes of what to expect in 2021.
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The good news: An “increase” is now likely to appear
For the past few months, historical economic weakness has been linked to COVID-19 and shutdowns by non-essential companies looked like the Social Security’s 2021 COLA would be threatened. The Consumer Price Index for All Urban Consumers (CPI-U), an inflation measure similar to the CPI-W, recorded seasonally adjusted price declines in March, April and May for its predetermined rate of goods and services.
But there is good news: Inflation is rising again.
Despite the CPI-U showing an unadjusted 12-month decline (ending July 2020) of 11.2% for all energy items, as well as a 6.5% decline in clothing and a 3.7% decline in costs for transportation services, the prices of other major expenses have risen. Food costs for food, as a whole, are 4.1% over the 12-month lagging period, with shelter and health care services up 2.3% and 5.9% respectively.
The latest BLS inflation report lists the CPI-W reading for July 2020 at 252,636. This is 0.96% up from July 2019, and marks an increase of 0.97% from the average CPI-W reading of 250,200 in the third quarter of 2019. Moving to the nearest whole number, are Social Security beneficiaries currently for a 1% increase in their benefits for 2021.
Keep in mind that this is only a single month of data, with August and September still to be taken. Nevertheless, it is a striking turnaround where things were straightened out just two to three months ago.
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The bad news: the purchasing power of Social Security will almost certainly take a hit
Now for that bad news.
Although any positive COLA is better than no COLA at all, a 1% “increase” would represent the second-smallest positive increase in the past 46 years, with only the 0.3% COLA from 2017 smaller.
You might think that a small COLA is not that big. After all, the CPI-W is designed to really benefit from inflation based on what people stand for.
But the problem is that the CPI-W does a very poor job of measuring the inflation that senior citizens are participating in, because it is an inflation index that tracks the spending habits of urban and church workers. They are not normally seniors, and they rarely benefit from Social Security.
In other words, the CPI-W tends to underweight important expenditures for seniors, such as health care and shelter, while giving too much weight to costs that are simply not significant, such as clothing and education. Since the year 2000, this has reduced the purchasing power of social security dollars for retired workers by 30%, according to an analysis by The Senior Citizens League.
A COLA of 1% in 2021 will simply not do much for the older beneficiaries of Social Security. Since health care and shelter costs account for close to half of the monthly expenses of all seniors, and prices for these two categories were up 5.9% and 2.3% respectively, in the 12-month lag period, it seems a decline in purchasing power for seniors as an almost certainty in 2021.
