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The most important day of the year for Social Security beneficiaries is now just 18 days away. On Oct. 10, 2019, the U.S. Bureau of Labor Statistics (BLS) will release inflation data from September. This inflation data is the last piece of the puzzle needed to calculate Social Security's cost-of-living adjustment (COLA) for 2020.

Think of COLA as the "raise" that program recipients will receive next year. But also understand that it's not a raise in the true sense of the word. Rather, it's a higher payout that's designed to keep pace with the rising cost of goods and services that beneficiaries are facing.

What can the more than 63 million beneficiaries expect for Social Security's COLA in 2020? With the BLS releasing the second piece of the puzzle on Sept. 12, we can finally take a deeper dive to narrow things down a bit.

But before we do that, I believe a brief refresher of how Social Security's COLA is calculated is in order.

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The 411 on how Social Security's COLA is calculated

As some of you may already know, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been the inflationary tether for Social Security since 1975. The CPI-W has eight major spending categories and a slew of subcategories, all of which have assigned weightings that help determine broad-based inflation. Every month, the BLS releases the previous months' inflation data, with the CPI-W being one of the readings it reports.

The thing to know about Social Security's COLA is that only readings from the third quarter matter. This means that the CPI-W readings from July, August, and September will determine recipients' COLAs next year, while the other nine months aren't taken into account. Nevertheless these non-used months can offer inflationary trends or clues that can help beneficiaries estimate what COLA might be in the upcoming year.

Here's how it works: The Social Security Administration takes the average CPI-W reading from the third quarter of the current year and compares it to the average CPI-W reading from the third quarter of the previous year. If the average third-quarter reading in the current year has risen from the previous year, it signals inflation, with the program's COLA equating to the percentage increase in the year-over-year value, rounded to the nearest tenth of a percent. In the rare instance where prices fall from one year to the next (i.e., deflation), benefits remain static.

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Here's where Social Security's 2020 COLA stands, as of now

With the BLS releasing July's inflation data in the second week of August, and August's inflation data on Sept. 12, we now have two of the three important puzzle pieces needed to determine Social Security's 2020 COLA. To be clear, this does not mean we know Social Security's 2020 COLA. However, the range of what to expect has been narrowed down significantly.

Here are the two meaningful CPI-W readings we have so far in 2019:

  • July: 250.236
  • August: 250.112
  • September: Will be reported on Oct. 10, 2019

And here's how the data came in during the third quarter of 2018:

  • July: 246.155
  • August: 246.336
  • September: 246.565

As you'll note, modest inflation was observed in each successive month last year, whereas the sequential monthly reading in August 2019 actually declined slightly from the July reading. According to percent changes in the Consumer Price Index for All Urban Consumer (CPI-U) in Augut, a similar index to the CPI-W, shelter and medical care inflation have, again, been robust (3.4% and 4.3%, respectively), while energy prices have weighed on inflationary indexes.

More important, though, is the difference between the third-quarter averages. Last year, the CPI-W averaged 246.352 in the third quarter. Through two months in the third quarter of 2019, the average CPI-W reading is 250.174, or an increase of 3.822. On a percentage basis, this is an increase of 1.55% over the previous year, implying a COLA, when rounded, of 1.6%.

Again, I want to be clear that this doesn't guarantee that COLA will come in at 1.6% in 2020. We still have an entire month of data needed before anything will be official. But it's pretty safe to suggest that Social Security's 2020 COLA isn't going to deviate too far from a 1.6% increase next year.

Image source: Getty Images.

The loss of purchasing power is likely to continue

The unfortunate thing is that no matter what COLA is ultimately passed along in 2020, the seniors who rely on Social Security as a primary source of income are still going to be in poor shape.

Though the CPI-W has been the program's inflationary tether for more than four decades, it doesn't do a particularly good job of accounting for the inflation that seniors are contending with. That's because, (as the indexes official name implies) it's tracking the spending habits of predominantly working-age urban and clerical workers. These are folks who spend their money very differently than seniors.

This disparity was shown in a side-by-side comparison back in December 2011 offered by the BLS of the CPI-W and an experimental index, the Consumer Price Index for the Elderly (CPI-E). The data collected showed that seniors spend twice as much of their monthly expenditures on medical care, and a notable amount more on housing than urban and clerical workers. Yet, the CPI-W tends to underweight these expenditures, and instead gives more weighting to categories like transportation, apparel, and education, which simply aren't that important to retired workers.

According to an analysis released earlier this year by The Senior Citizens League, seniors have seen the purchasing power of their Social Security dollars decline by a third since 2000. With few exceptions, this erosion in purchasing power is likely to continue as long as the CPI-W remains the program's inflationary tether.

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