Monthly Social Security benefit checks are likely to increase next year to the maximum they have in 40 years.
Many retirees welcome this news, as they have been complaining for years that annual Social Security cost-of-living adjustments have been too low. The COLA that came into force in January this year, for example, was only 1.3%.
His reaction betrays a fundamental misunderstanding of what COLA stands for. Economists refer to this misunderstanding as “inflation illusion” or “money illusion” and does not lead to any end to confusion.
This is because the Social Security COLA (in theory) leaves you neither better nor worse than before. When inflation is high, you need a bigger COLA to make you whole again. In this case, you are no richer than you would have been in a low-inflation environment with a correspondingly low COLA.
Of course, we still don’t know for sure what the Social Security COLA will be for 2022, as it is based on the 12-month inflation rate until the third quarter of this year. This means that the precise COLA will not be known until the September inflation data, which is scheduled for October 13th, is released. But Alicia Munnell, director of Boston College’s Retirement Research Center, estimates it will be 6%. If so, the COLA will be the highest since 7.4% in 1982.
Different measures of inflation
In theory, therefore, there is no reason why this year’s biggest COLA will make you happier than last year’s much smaller COLA.
Theory and practice do not always coincide, of course. In practice, COLA can leave you worse off than before if the measure of inflation on which COLA is based is flawed. While the scope of this column is beyond the full treatment of the pros and cons of different measures of inflation, here’s a quick review of some of the top candidates that Social Security could use:
• CPI-W. This is the version that, by law, the Social Security Administration must currently use. It is formally known as the “Consumer Price Index for All Urban Employees and Office Workers” (CPI-W), and is slightly different from the CPI number shown each month, which is technically the “Consumer Price Index for All Urban Consumers” (CPI-U). Over the past few decades, the CPI-W has grown at a slightly higher rate than the CPI-U, only 0.1 percent of an annualized percentage.
• CPI-E. This means “Consumer Price Index for the Elderly” and the SAA calculates it taking into account the different spending habits of the typical elderly person. Over the last four decades, the CPI-E has appreciated at an annualized rate of 0.2 points faster than the CPI-W. While many in Congress have introduced legislation that requires SSA to establish COLA through the CPI-E, Munnell argues that it may not be worth it. This is because most of the historical difference between the CPI-E and the CPI-W goes back to the previous one until 2002; since then, he points out, there have been virtually no differences.
• Covid-IPC. As I pointed out a year ago, some believe that the COVID-19 pandemic has made the CPI-U and CPI-W especially poor in real inflation reflection. One who makes this argument is Alberto Cavallo, a professor at Harvard Business School, who a year ago calculated that real inflation was 0.6 percentage points higher than reported. This year, however, the difference remains the other way around: in the last twelve-month period, its CPI-Covid has been 0.6%. lower than the CPI.
While I will leave it to others to debate the fullness and disadvantages of each of these and other definitions, I want to put them in context. Currently, the average monthly Social Security benefit is $ 1,543, so even a full percentage difference in COLA translates to just $ 15.43. And most of the differences between the various definitions are less than a full percentage point. One-tenth of a percent translates to about $ 1.54 a month.
This may not be enough to worry about, as there are many other retirement funding issues that make a much bigger difference.
When will the money stay in Social Security?
One of the most important issues in this news this week is the latest report from the top actuary of the Social Security Administration on the solvency of Social Security trust funds. As widely reported, this latest report estimates that the two main trust funds (Old Age and Survival Insurance – OASI – and Disability Insurance – DI) together will not be able to pay 100% of benefits from 2034 – one year earlier than projected a year ago.
You may be wondering how to square this finding with my analysis, just a week ago, which gave good news about Social Security funding. There are two reasons:
• It is not entirely correct to say that the principal actuary reports that the Social Security trust funds will run out of money sooner than previously thought. In both last summer’s and last fall’s updates, the lead actuary had already indicated that the combined OASI and DI trust funds would run out in 2034. His new report this week only reaffirms that estimate. And this is good news because it means that, after almost a year of additional analysis, some of the worst-sounding scenarios on Social Security funding have not been met.
• I based my assessment of “good news” on an actuarial report from the Congressional Budget Office, which calculated that the OAS trust fund would run out of money in 2032, instead of 2031 as expected previously. In his latest report, the chief actuary estimates that this particular trust fund will not be exhausted until 2033, which is a year later than the OBC estimates. This is also good news.
Mark Hulbert regularly contributes to MarketWatch. His Hulbert Ratings keeps track of newsletters about investments that pay a fixed fee to be audited. You can contact him at [email protected].