Understanding how Social Security’s COLA is calculated

However, beneficiaries don’t have to wait for the official announcement from the SSA to calculate their Social Security COLA for 2019. Once the Bureau of Labor Statistics (BLS) has released its September 2018 inflation data, we have all the information needed to determine how much of a raise Social Security recipients will receive next year.

You see, Social Security’s inflationary tether, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), only takes into account three months of inflation data rather than a full year. The average reading of the CPI-W during the third quarter of the previous year (July through September) acts as the baseline figure, while the average reading from the third quarter of the current year is the comparison. It takes the BLS a good week or so to compile all the data for the CPI-W’s main spending categories and subcategories, which is why the data release doesn’t come out until the second week of the following month.

If the average reading from the third quarter of the current year rises from the average CPI-W reading from the previous year, then beneficiaries receive a raise that’s commensurate with the percentage increase, rounded to the nearest 0.1%. And should prices fall year over year, as happened in 2010, 2011, and 2016, benefits remain static from one year to the next.

The good news for beneficiaries is that prices most definitely rose on a year-over-year basis. Let’s dive in to take a precise look at how the 2019 Social Security COLA was determined.

Here’s your 2019 Social Security COLA

We begin by laying out the three important CPI-W readings from the third quarter of 2017 that form the baseline figure.

• July 2017 CPI-W: 238.617
• August 2017 CPI-W: 239.448
• September 2017 CPI-W: 240.939

If these figures are added up and divided by three (since there are three months taken into account), then the average CPI-W reading works out to 239.668.

With the release of September’s CPI-W data today (October 11), we now have the final piece of the puzzle to figure out the comparison figure for 2018.

• July 2018 CPI-W: 246.155
• August 2018 CPI-W: 246.336
• September 2018 CPI-W: 246.565

Like before, if we add these figures up and divide by three, we get an average of 246.352. If we then subtract the average third-quarter reading in Q3 2017 from the average CPI-W reading in Q3 2018, we’re left with 6.684. Divide this figure by the average reading of 239.668 from the third quarter of last year, and we get a 2019 COLA of 2.8% when rounded to the nearest 0.1%.

For context, this is the highest annual raise that beneficiaries have received in seven years.

Before you get too excited, remember this

Of course, Social Security recipients, or should I say more specifically aged beneficiaries, aren’t going to want to break out the champagne just yet. That’s because the CPI-W has a natural flaw, which results in seniors losing purchasing power over time on their Social Security income.

According to a report from The Senior Citizens League, the purchasing power of Social Security dollars has declined by an almost jaw-dropping 34% since 2000. Put another way, what $100 worth of Social Security benefits could buy 18 years ago can now only buy $66 worth of those same goods. Inflation (i.e., the rising price of goods and services) has eaten the rest.

You’re probably scratching your head and wondering how the CPI-W, which is designed to measure inflation, has allowed Social Security’s COLA to so vastly underrepresent the inflation that senior citizens are facing. The answer lies with the group of folks the CPI-W is following.

As the name implies, the CPI-W measures the spending habits of urban wage earners and clerical workers, who spend their money very differently than seniors do. This results in substantially more weight being placed in spending categories unimportant to aged beneficiaries, like education and transportation, while critical expenses like medical care and housing don’t get as much attention as they should. As a result, the purchasing power of Social Security dollars remains in constant decline for the seniors who rely on the program.

In other words, seniors should definitely relish the fact that they’re on track to receive their biggest COLA since 2012, but they’re not going to gain any ground they’ve lost due to inflation since 2000.