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The First of 3 Social Security Inflation Data Points Used to Calculate COLA Is In

Sean Williams, The Motley Fool

There's little doubting the role that Social Security plays in laying a financial foundation for our nation's retired workforce. According to the Social Security Administration, more than three out of five aged beneficiaries relies on their monthly check to account for at least half of their income, with 34% leaning on the program for essentially all of their income (90%-plus).

Though future generations of retirees believe they'll be less reliant on Social Security as a "major" income source, a survey from Gallup in April 2018 found that 84% will still lean on their monthly payout to make ends meet during retirement.

A hundred dollar bill and twenty dollar bill partially covering a Social Security card.

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Social Security's 2019 COLA announcement is just two months away

Given this importance, there's probably no event more closely monitored than the annual cost-of-living-adjustment (COLA) announcement in mid-October. COLA is the "raise" that existing beneficiaries will receive come Jan. 1, and it's supposed to be representative of the inflation the program's recipients have contended with since their last raise.

Social Security's COLA is determined by the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. It takes into account eight major spending categories, which are themselves often comprised of numerous subcategories, and analyzes the price action for a broad basket of goods and services.

But here's the interesting thing about calculating Social Security's annual COLA: the full year doesn't come into play. Instead, the average reading from the third quarter of the previous year (July-September) acts as the baseline, while the average reading from the third quarter of the current year is the comparison. If prices rise in the third quarter of 2018 from the third quarter in 2017, then beneficiaries will receive a "raise" that corresponds to the difference in percentage terms (rounded to the nearest 0.1%).

In the rare instance that prices fall year over year, as they did in 2010, 2011, and 2016, then Social Security benefits remain the same from one year to the next. Thankfully, deflation cannot reduce what beneficiaries are receiving.

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The first piece of the puzzle has been released

Since CPI-W inflation data from the Bureau of Labor Statistics (BLS) is typically released in the second week following the end of the previous month, the BLS announced July's inflation data on Friday, Aug. 10. Though the release primarily covers the goods and services that influenced the Consumer Price Index for All Urban Consumers (CPI-U), it does note that the CPI-W rose by 3.2% on an adjusted basis over the previous 12-month period. This reading is the first of three months that does count toward next year's COLA. 

What goods and services are pushing inflation higher, you ask? Again, keeping in mind that we're looking at the CPI-U and not the CPI-W, energy has been the key upward catalyst. On an unadjusted 12-month basis, gasoline and fuel oil prices are up 25.4% and 34.7%, respectively. Though these two expenses only account for a little more than 4.6% of the total CPI-U weighting combined, substantially higher crude oil prices have certainly played a role.

If there's one other expense to point to, it'd be shelter, which is the highest-weighted component of any inflationary index. For the CPI-U, shelter accounts for nearly 33% of the weighting. Over the past 12 months, unadjusted inflation totaled 3.5%, with rent of primary residences rising 3.6%, and owners' equivalent rent of residence increasing 3.4%.

Though there are still two more readings left to be released for the months of August and September, signs are pointing toward seniors receiving their biggest annual COLA since 2012.

A confused elderly man staring at a small pile of coins in a woman's hand to his left.

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Now for the bad news

The downside is that COLA isn't a means for beneficiaries to "get ahead." In an ideal world, it's going to perfectly account for the inflation that all beneficiaries are coping with. But we're in far from an ideal world.

The biggest problem with Social Security's COLA is that the CPI-W tracks the spending habits of working-age urban and clerical workers rather than seniors, who happen to make up around 70% of the programs' beneficiaries. And, as you probably surmised, working-age Americans spend their money differently than retired workers. This results in housing and medical-care expenses being underreported, since working-age urban and clerical workers don't spend as much of their money on these two expenses as seniors. Meanwhile, less important expenses to seniors, such as transportation, apparel, and education, are given more weighting by the CPI-W. Ultimately, it means seniors aren't getting the raise they deserve.

According to an analysis from The Senior Citizens League, the purchasing power of Social Security dollars has declined by 34% for aged beneficiaries since 2000. What $100 in Social Security income used to buy in 2000 can now only buy $66 worth of those same goods and services. This is a trend that shows little signs of slowing, meaning even a 3%-plus COLA in 2019 is going to keep most senior citizens well behind the eight-ball.  

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