Inside the Social Security COLA Calculations

The Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W, is Social Security's annual inflationary benchmark to determine cost of living increases for Social Security recipients. This number rose 8.5% over the past 12 months and 0.1% for the month, prior to seasonal adjustment.

This CPI-W includes a long list of major and minor spending categories, each of which has its own respective percentage weightings.

These weightings allow the CPI-W to be expressed as a single figure, which can easily be compared to the previous month or year to determine if prices for a predetermined basket of goods and services have risen or fallen.

The Clients Affected

The Old-Age, Survivors, and Disability Insurance Program, or OASDI, covers three primary groups of people.

1. People Who Have Retired

• Workers, whether employed by someone else or who were self-employed, who paid payroll taxes.
• The spouses of retired workers who are eligible for Social Security retirement benefits, either because the workers' earnings were significantly higher than the spouses' earnings, or because the spouses did not work outside the home.
• Ex-spouses who were married for at least 10 years to workers, who are not currently married, and who either earned much less than their working spouses or who did not work outside the home.
• The children of workers who have filed for retirement benefits and who have one or more children under a certain age.

2. Survivors of People Who Retired and Later Died

• The spouses and children of people who were receiving retirement benefits and has died.
• An ex-spouse of a person who was receiving a retirement benefit and has died.

3. People With Disabilities

• People who qualify for Social Security Disability Insurance benefits.
• The children of recipients of SSDI benefits, if the children are under a specified age.

What the COLA Does

The Social Security COLA is like a pay raise. It helps Social Security recipients keep up with the effects of inflation on the prices of goods and services.

If buying the same amount of goods and services costs more this year than it cost last year, then, ideally, Social Security checks should increase by the same amount, so the recipients don't lose purchasing power.

When there is a Social Security COLA, the amount paid to all Social Security benefits recipients goes up.

In addition to increasing the benefit that current Social Security recipients receive, the COLA is also used as a basis for calculating the benefits that future recipients will receive, as well as the benefits that certain retirees who worked for the federal government receive.

So, whether your client has started receiving your Social Security benefit or not, the COLA will affect any Social Security benefits that your client will ever receive.

How Social Security Managers Calculate the COLA

The U.S. Bureau of Labor Statistics (BLS) released the September inflation data this morning.

Social Security managers compared the average CPI-W reading from the third quarter of the current year, which ended Sept. 30, with the average CPI-W reading from the third quarter of 2021.

The year-over-year percentage increase in CPI-W, rounded to the nearest tenth of a percent, determines how much Social Security checks will climb in 2023.

CPI-E vs. CPI-W

One problem with the Social Security COLA system is that it's based on the CPI-W.

The items included in the CPI-W are not the same items that most retirees buy.

Many economists and retirement income experts believe that the consumer price index for the elderly, or CPI-E, more accurately reflects changes in elderly people's spending. The CPI-E, which measures prices of a basket of items often purchased by people ages 62 and older, places a higher weight on medical care and shelter than two other commonly used inflation indexes do.

Some observers believe that CPI-W is good enough for COLA calculations because seniors, like other consumers, make substitutions.

If beef prices rise sharply, seniors might switch to chicken.

Further, retirees' spending habits might protect them from inflation.

But the Senior Citizens League analyzes Social Security benefits' purchasing power by comparing Social Security COLAs with increases in the price of 37 goods and services typically used by retirees, and it says inflation has caused retirees' Social Security benefits to lose 40% of their buying power since 2000.

While prices rose in almost every spending category, benefits were most affected by sharp increases in costs for home heating, gasoline and food, and by a 14.5% increase in Medicare Part B premiums in January 2022.

The Medicare Part B premium will fall in 2023; however, that reduction is small relative to the increase in spending on other items.

Taxes

One byproduct of a large COLA increase for Social Security recipients in 2023 is a possible increase in tax liability.