After months of anticipation, retirees now know that their Social Security benefits will officially go up by 8.7% in 2023, due to the most significant cost-of-living adjustment (COLA) in more than 40 years.
In September, the average monthly Social Security check for retirees was $1,628.17, meaning that next year retirees may see their monthly benefits increase by more than $141, which equates to an annual bump of more than $1,692.
The increase is badly needed considering how high inflation has been this year, which has raised the cost of goods and services everywhere from the pump to the grocery store. While the big increase is welcome news, it could also be the largest annual increase to Social Security benefits for quite a while. Here’s why.
How the COLA is calculated
Each year, the Social Security Administration (SSA) increases retirees’ benefits to account for inflation, which increases the cost of living. This is known as the COLA adjustment.
To calculate the COLA increase, the SSA looks at inflation based on data from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This index tracks and measures the price changes on a market basket of consumer goods and services for items purchased by urban wage workers and clerical workers in various parts of the U.S.
Specifically, the SSA looks at the CPI-W during the third quarter of the year, which includes the months of July, August, and September. To calculate the COLA, the SSA takes the average CPI-W in the third quarter of the year and then compares it to the average CPI-W for the same period in the prior year. The percentage difference determines the COLA for the following year, although benefits can never be decreased.
The main thing to understand here is that the COLA is heavily dependent on inflation, so if there is a lot of inflation one year you can probably expect a good-sized COLA increase the following year.
Inflation is expected to soon peak
You wouldn’t know it by looking at recent inflation data, but most experts expect inflation to soon peak and consumer prices to grow at a slower pace than what we’ve seen this year.
A closely watched survey conducted by the University of Michigan showed that consumers expect prices to increase by 5.1% in a year from now, and by 2.9% over the next five years. Those expectations have actually increased since September and represent a strong dose of continued inflation, but it’s still not as much inflation as we’ve seen this year.
This University of Michigan survey, however, isn’t the only group expecting the pace of inflation to slow in the coming years. The International Monetary Fund is forecasting that global inflation will be 6.5% in 2023 and 4.1% in 2024.
The research firm Morningstar also expects inflation to abate over the next several years. Looking at the Personal Consumption Expenditures Price Index (PCE), the Federal Reserve’s preferred gauge of inflation, Morningstar expects the PCE to be up 5.9% in 2022 but then average just 1.5% growth between 2023 and 2026.
Future COLAs could still be decent
One of the reasons that so many economists and experts expect inflation to slow in the near future is because the Fed has now aggressively raised interest rates and could keep doing so later this year.
These by design are expected to bring prices down by making things like mortgages more expensive and therefore reducing demand, which over time tends to cool prices. Considering the Fed has raised interest rates by so much in such a short period of time, economists do expect to see a cooling effect at some point — but it can take some time to play out.
That’s why I don’t think inflation will rise as much as it has this year anytime soon, which is why I don’t expect to see another 8.7% Social Security COLA increase anytime soon. Future COLAs could continue to be above average over the next few years, though it would ultimately be good for most people’s finances right now if inflation slows.
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