Personal Finance

Are Social Security Benefits Really Protected Against Inflation? Here's the Scoop

Maurie Backman

Published: December 7, 2024 12:41 pm

Key Points from 24/7 Wall St.

• Social Security benefits are eligible for annual cost-of-living adjustments (COLAs).
• While COLAs are supposed to help seniors maintain buying power, they often fail.
• A large flaw in the way Social Security COLAs are calculated is to blame.
• Also: Take this quiz to see if you’re on track to retire (Sponsored)

Millions of older Americans receive monthly payments from Social Security. And thankfully, there’s a system in place to help ensure that benefits are able to keep up with inflation through the years. It’s called cost-of-living adjustments, or COLAs. And they’ve been around since 1975.

This isn’t to say that Social Security benefits didn’t rise over time prior to 1975. But back then, benefit increases were set by legislation. It wasn’t until 1975 that COLAs happened automatically.

But while Social Security COLAs are clearly supposed to protect seniors against inflation, whether they actually manage to do that is a different story. And a big reason COLAs tend to fall short boils down to a problem with the way they’re calculated.

The current system doesn’t work

Social Security COLAs are calculated based on changes to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). When there’s a rise in the CPI-W from one year to the next, Social Security benefits increase. When the CPI-W remains flat, benefits remain flat. And when there’s a decrease in the CPI-W, benefits also remain flat. Seniors are protected so that their monthly checks can’t decrease from one year to the next.

All of this might seem perfectly fair at first glance. But the problem stems from the fact that Social Security recipients often bear expenses that the CPI-W doesn’t capture.

Healthcare costs, for example, aren’t heavily weighted in the CPI-W, but they’re a huge expense for older people — those most likely to be collecting Social Security. On the flipside, urban and clerical workers are more likely to spend a large chunk of their income on transportation and commuting, which may be a smaller expense for retirees not traveling to a daily job.

This mismatch is exactly why Social Security COLAs haven’t held up well over time. The nonpartisan Senior Citizens League says that this year’s average Social Security payments are only worth about $0.80 on the dollar compared to 2010. This means that in the past 14 years, Social Security recipients have lost 20% of their buying power.

Will a new system be implemented?

In recent years, Social Security recipients saw some of the largest COLAs in history. Despite those raises, seniors on Social Security are still grappling with a major loss of buying power.

Clearly, something needs to be done to allow Social Security COLAs to better keep pace with inflation. And the solution may boil down to changing the method by which they’re calculated.

Some experts have pushed for a shift to the Consumer Price Index for the Elderly as a benchmark for calculating COLAs. And that makes sense. An index that captures costs specific to seniors would more likely result in more impactful COLAs.

But lawmakers would need to push that change through for seniors on Social Security to gain buying power. And it’s unclear as to whether the incoming administration is interested in making such a change.

In fairness, lawmakers also have the daunting task of preventing Social Security cuts to grapple with. Adjusting the ways COLAs are calculated may have to sit on the back burner until the greater issue is sorted out.