Inflation news seems to be getting worse every month, and the latest report in March indicated that prices of goods and services rose 8.5% year-on-year. This is the largest annual price increase since 1981. The big bump was driven by rising costs of necessities, including housing, gas and food.
Unfortunately, this soaring inflation is really bad news for retirees. The rapid rise in prices not only erodes the purchasing power of their savings, but it also shows a really big problem with how Social Security Cost of Living Adjustments (COLAs) are calculated.
There is a big problem with social security schemes
Social Security COLAs are designed to help ensure that retirees do not lose purchasing power when prices rise.
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To measure whether prices are rising and how much, the consumer price index for urban workers and office workers (CPI-W) is used. This price index measures the cost of a wide range of goods and services. Social Security’s COLA is determined based on changes in CPI-W. For example, if the CPI-W shows that prices have risen 2% year-on-year, retirees will get a 2% increase.
However, only certain months’ CPI-W data are used. Specifically, COLA is based on average prices in the third quarter of the year before the increase occurs. So the only relevant months in terms of whether retirees get a pay rise or not are July, August and September. To be clear, this means that the wage increase seniors received in 2022 was determined based on how much prices increased year-over-year measured in July, August and September 2021 compared to the same months in 2020.
The problem is that inflation has risen since then. As a result, retirees have lost a significant amount of purchasing power this year. Retirees received a 5.9% benefit increase in 2022. But with prices currently rising by 8.5% compared to the same time last year, their benefit increase is far from keeping pace with rising costs.
The fact that the purchasing power of services has eroded so much this year shows the problem that can arise when inflation rises. As the pension increase is based on older data, a rapid rise in prices can lead to serious financial difficulties – especially because the purchasing power of investment savings also decreases when costs increase.
What can retirees do?
The COLA formula simply does not respond to rising inflation, and there is nothing retirees can do about the fact that their social security increase may be too small when prices rise rapidly after their benefit increase has been calculated for the year.
But seniors can adjust their budgets to ensure they do not end up in debt or deducting too much from their investment accounts when this happens. The sooner older Americans look for ways to reduce spending as prices rise, the more likely they are to maintain their long-term economic security.
Future retirees should also be aware that COLAs may not ensure that pension benefits do not fall in value, so they should make sure they have plenty of savings to finance a comfortable life, even if social security falls short.
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