Social Security’s Historic 2023 COLA Comes With a Silver Lining

The wait for Social Security’s more than 65 million beneficiaries, a majority of whom are seniors, is nearly over. In just 10 days, the U.S. Bureau of Labor Statistics will release key inflation data that serves as the final puzzle piece to calculate Social Security’s cost-of-living adjustment (COLA) for the upcoming year.

Since polls and studies have shown how vital Social Security income is to the financial well-being of most retirees, knowing how much payouts are going to rise in 2023 is of the utmost importance to older Americans.

Social Security’s cost-of-living adjustment (COLA) is the biggest announcement of the year

The easiest way to think of Social Security’s COLA is as a mechanism to account for the inflation — i.e., rising price of goods and services — program recipients are contending with. If retired workers rely on their Social Security income to buy a certain amount of goods and services, and those goods and services increase in price, ideally, we should see benefits rise by a complementary amount. COLA is simply the “raise” passed along most years to keep Social Security payouts on par with inflationary increases.

Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been the inflationary tool used to determine the program’s COLA. This is an index with more than a half-dozen major spending categories and a multitude of subcategories, each of which has its own respective percentage weighting. These weightings allow the CPI-W to be expressed as a single number, which makes for easy month-to-month or year-over-year comparisons to determine if inflation or deflation (falling prices) has occurred.

Calculating Social Security’s COLA involves taking the average CPI-W reading from the third quarter (Q3) of the current year (July-September) and comparing it to the average CPI-W reading from Q3 of the previous year. If the current-year figure is higher, it means inflation has occurred and beneficiaries are getting a “raise.” The year-over-year percentage increase in the average Q3 CPI-W, rounded to the nearest tenth of a percent, is what determines how large of a “raise” Social Security beneficiaries will receive.

Historically high inflation should result in a big increase for Social Security checks in 2023 U S. Inflation Rate data by YCharts.

The program’s “historic” COLA could lead to disappointment

In 2023, essentially all program recipients should enjoy their largest increase to Social Security benefits on record. Historically high inflation is expected to push the cost-of-living adjustment to 8.7%, according to an estimate from Social Security policy analyst Mary Johnson of The Senior Citizens League (TSCL), a nonpartisan senior advocacy group. An 8.7% COLA would mark the largest year-over-year percentage increase in 41 years, as well as the biggest nominal dollar hike in the program’s storied history.

If we assume Johnson’s forecast is correct, the average retired worker is looking at a $146/month increase to their Social Security check next year. Meanwhile, the average disabled worker and survivor payout are estimated to rise by $119/month and $116/month, respectively, in 2023.

However, Social Security’s COLA usually isn’t all that it’s cracked up to be. For instance, rapidly rising food, shelter, and energy expenses are expected to chip away at a significant portion of next year’s benefit increase. The reason 2023’s COLA will be “historic” is because consumers have been dealing with historically high inflation.

What’s more, an analysis by TSCL in May found that the purchasing power of a Social Security dollar has declined by an appalling 40% since 2000. The CPI-W simply hasn’t done a good job of accounting for the inflation that matters to seniors. Since the CPI-W tracks the spending habits of “urban wage earners and clerical workers,” key expenditures, such as medical care and shelter, are being underweighted. This is what’s led to the chronic loss of purchasing power over the past 22 years.

There’s a surprising silver lining in Social Security’s 2023 COLA

Although Social Security’s COLA has led to a number of disappointments throughout the years, the upcoming “raise” for 2023 actually comes with a bit of a silver lining.

Last week, the Centers for Medicare and Medicaid Services (CMS) released the 2023 premiums, deductibles, and coinsurance amounts for Medicare’s Part A (inpatient care), Part B (outpatient services), and Part D (prescription drug) programs. Since most of Social Security’s retired workers are enrolled in Medicare, they’re used to having their Part B premiums automatically deducted from their monthly retired worker benefit.

Over the past quarter of a century, you’d only need one hand, and not even all the fingers on that hand, to count the number of times Medicare Part B premiums have declined on a year-over-year basis. In fact, 2022 marked one of the largest year-over-year percentage increases in Part B premiums in history (14.5%). But there’s a reprieve coming in 2023.

According to the CMS, Medicare Part B premiums will fall roughly 3% to $164.90/month in 2023 from $170.10/month in 2022. The annual deductible for Part B beneficiaries will also decline by $7 from $233 in 2022 to $226 in the upcoming year. Take note that these declines in Part B premiums also apply to high earners ($97,000+ in modified adjusted gross income) that face a premium surcharge.

The huge Part B hike in 2022 was due, in part, to the uncertainties of covering Biogen‘s costly Alzheimer’s disease drug Aduhelm. But thanks to lower-than-expected spending on Aduhelm and a significant increase in the Supplementary Medical Insurance Trust Fund, these excess reserves can be used to lower Part B premiums next year.

In other words, the silver lining for tens of millions of aged beneficiaries is that they may actually get to keep a bit more of their COLA in 2023 after all, rather than losing it to Part B premium increases and/or inflation.

However, don’t be fooled into thinking that beneficiaries are somehow “getting ahead.” No matter how high Social Security’s cost-of-living adjustment is in 2023 or in the years to follow, it’s going to be virtually impossible to make up for a 40% loss of purchasing power since 2000.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Biogen. The Motley Fool has a disclosure policy.