Probably the most closely followed news on Social Security is the announcement of the annual cost of living adjustment (“COLA”). It is close to a senior’s versions of Super Bowl Sunday.
That process started this morning with the latest inflation data from Bureau of Labor Statistics (BLS). As CNBC reported: “U.S. TREASURY YIELDS JUMP AFTER JUNE CORE CPI POSTS BIGGEST GAIN IN 1-1/2 YEARS, JOBLESS CLAIMS FALL”. For seniors, this might be a very good start for earnings season.
Since 1975, the COLA has been tied to the 3rd quarter changes in the “Consumer Price Index for Urban Wage Earnings and Clerical Workers” or (CPI-w). While the government releases CPI-w data every month, the COLA calculation only uses readings from the third quarter (July through September).
This is what the formula looked like last year. As you can see from the chart, the average CPI-w for the 3rd quarter of 2017 was 239.668. The average CPI-w for the 2018 was 246.565. Through the magic of division (246.565 / 239.668 = 1.0279 or), we get 2.8%.
For more than a month, financial bloggers have been front-running the story in hopes of being right. At this point, the numbers suggest a smaller bump than last year. I will spare you the details because no one knows what the next three months hold.
This release provides the first pillar of the outcome, and the other two blanks will be filled in over the coming months. For the time being, it is sufficient to know that it is game-on from now to the middle of October.
Key Points about the COLA
Some things to know about the COLA:
- It is not a benefit increase. It is the cost for seniors to stand-still economically against the flow of inflation.
- Separately, the COLA could be one of the most costly components in Social Security. In its assessment of the Social Security 2100 Act, the experts at the Social Security Administration estimated that increasing the COLA just .2 percent above CPI-w would cost around $1.7 (2019 $s) trillion over 75 years. That is a lot of greenbacks to give lower-income workers about $2 extra per month. (Author’s note: I will explain in the comments for those who are terribly interested in numbers.)
This presents a dilemma for seniors. On one hand, benefit checks rise with CPI. On the other, so does programmatic cost.
While 1.7% is not likely to impress seniors, it is a plus for the system as a whole because as the program’s trust funds face depletion faster as inflation rises. The reason is that revenue is largely tied to wage growth, and expenses are tied to inflation. The only real question is whether employees are in a position to negotiate wages increases that compensate for the rising costs.
The Social Security Trust Fund
The aspect of the program that clearly can’t renegotiate compensation is the Trust Fund, which is a portfolio of bonds with terms locked on average for 7 years. Currently, the program earns 2.74% on reserves which isn’t a lot, and the mix will get worse rather than better (see the comments below if you love numbers).
Understand this: Inflation is programmatic cancer for Social Security. The reserves as a whole are apt to lose money every year until the program is exhausted in 2035 if the Trustees are right about future inflation.
To illustrate, take $100 in the Trust Fund. At the end of the year, it is worth $102.74. The cost of $100 of benefits will rise next year to $102.6. That is the cost of standing still.
While we can’t reprice the bonds, the cost of inflation will change every year.
This issue will get worse before it gets better. Last month the program purchased $180 billion in bonds that generate a tiny 2.25%. In the meantime, the program will redeem about $160 million in bonds which earned about 4% over the coming year.