Social Security: Inflation's Worst Nightmare

Social Security is supposed to be able to keep up with inflation. However, it doesn't.

Senior couple relax sleeping together in hammock sunny gardengetty
As the sun beats down on them, the elderly couple look contentedly relaxed, sleeping soundly in each other's arms in their hammock. It's a beautiful scene of marital bliss, and a reminder that love truly knows no bounds.

The Social Security program is supposed to provide benefits that keep pace with inflation, but it has fallen behind in recent years.

Today's the day retirees across the country learn how much their Social Security benefits will increase next year. The average recipient can expect to see their benefits increase by 8.7 percent, which will start showing up in their January checks. This is welcome news for seniors who rely on Social Security to help make ends meet. With the cost of living rising, the extra income will help them keep up with their expenses and maintain their quality of life.

The COLA is supposed to help us keep up with inflation, but it falls short. It's calculated based on the Consumer Price Index from the previous year, so we're always playing catch-up. This leaves us perpetually behind the eight ball.

Looking ahead to 2023, we can see that the cost of living will rise sharply, resulting in a 100% increase in the price of hot dogs. This will have a direct impact on seniors, who will see their benefits increase by $1,000 a month.

It's hard to keep up with the rising cost of living, and it seems like benefits never keep pace. It's especially frustrating when a program is supposed to be "neutral to inflation." That means that your benefits should keep up with the cost of living, but it doesn't always work out that way. For example, let's say you receive a $1,000 benefit in January. That benefit will be worth 1,000 wieners, but only 500 wieners in December. On average, over the year, you'll have received a benefit of 750 wieners. Yes, starting in January 2024, your benefit will rise to $2,000. So, in that month, your benefit will again buy 1,000 dogs. But if the price level doubles yet again in 2024, you'll, again, average just 750 dogs per month. If inflation continues to run at 100 percent annually, you'll experience a 25 percent permanent real benefit cut in a program that's supposed to be neutral to inflation!

In short, the lag in the inflation adjustment reduces our real benefits, with the reduction larger the higher the inflation rate. At a 10 percent inflation rate, you'll go from a benefit of 1,000 dogs in January to 909 dogs in December. On average, that's 954.5 dogs per month, meaning a real benefit cut of 4.55 percent over the year. This is a significant reduction in benefits for those who rely on them, and it will likely have a negative impact on the economy as a whole.

Inflation has been eating away at the purchasing power of Social Security benefits for years, and something needs to be done about it. The cost-of-living adjustment (COLA) currently only happens once a year, which leaves benefits lagging behind the true cost of living. If the COLA was calculated monthly, it would help to keep benefits more in line with actual costs. Congress needs to act to reform the Social Security COLA so that it accurately reflects the true cost of living.

It is clear that the pandemic has had a profound impact on the economy, with many people experiencing a significant drop in their real benefit. The CPI is based on the increase in the cost of the basket of goods and services purchased nationwide, but it is important to remember that inflation can vary greatly from person to person. For example, those who live in urban areas and enjoy dining out are seeing a significant increase in menu prices. While this may be different from what others are experiencing, it is clear that the pandemic has had a widespread impact on the economy.

Inflation is yet another obstacle for Social Security recipients to overcome. With benefits subject to federal income taxation (and in some cases, state income taxation), the thresholds beyond which first 50 percent and then 85 percent of our benefits are subject to taxation are not indexed for inflation. This means that each year of inflation, particularly high inflation, more and more beneficiaries are having more and more of their benefits taxed away. Social Security's nominal income-tax thresholds have been set in stone since 1983, but it's time for Congress to take action and index these thresholds.

With inflation, people working stand to experience a real benefit increase through what Social Security calls its recomputation of benefits, not because their real wages rose since age 60, but because their nominal wages (what they received in dollars) rose. Hence, if you had a low or spotty earnings history prior to age 60, this is the time to get back into the labor market to earn high nominal, if not high real wages. You may well raise your lifetime Social Security benefits by more than the additional FICA taxes you'll pay.

As someone who is nearing retirement age, it's important to be aware of how Social Security and inflation can affect your benefits. If you're waiting beyond full retirement age to start your retirement benefit, make sure you receive all your Delayed Retirement Credits (DRCs) and that they have been properly adjusted for the system's COLAs. For example, if your benefit, had you taken it at 69, was $X, your benefit at 70 should be $X times 1.08 — to account for the year's DRCs — times 1.087, if this year's COLA, as announced today, is 8.7 percent. I've been hearing from people not receiving the right number of DRCs or receiving DRCs that aren't properly inflation adjusted, so it's important to double check your benefits to make sure you're getting what you're entitled to.

Inflation can be a good thing for those people who are negatively affected by the Windfall Elimination Provision or the Government Pension Offset Provision. With enough inflation, people who are losing benefits due to these provisions may find that they start to receive a portion of those benefits again.