Social Security payments are a fixed amount, determined based on your career earnings. But the amount you receive from Social Security can still increase from year to year thanks to cost-of-living adjustments.
Every year, the Social Security Administration announces whether or not there will be a COLA for the following year, and if so, by what percentage the payments will increase. Here’s an explanation of what the cost-of-living adjustment is, why it’s important and what you can expect your payments to be through 2034.
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Social Security Payments
Social Security payments are designed to assist retirees with their living expenses. In some cases, Social Security makes up the bulk of a retiree’s income. Imagine if the value of those payments decreased every year instead of increasing. All other things being equal, this is what would effectively happen due to the effects of inflation. To counteract this, Congress passed cost-of-living legislation in 1972, and automatic COLAs began in 1975.
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How the Cost-of-Living Adjustment Works
The cost-of-living adjustment is determined every year by a formula contained in the Social Security Act. The COLAs are keyed to inflationary movements as represented by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which is calculated every month by the Bureau of Labor Statistics.
How the Cost-of-Living Adjustment Is Calculated
To determine the amount of a COLA, the average CPI-W from the third quarter of the previous year is compared with the same index from the third quarter of the current year. If there is an increase, the COLA becomes effective beginning Jan. 1 of the following year. But in a quirk of the system, all January Social Security payouts are made in December of the prior year, as Jan. 1, the regular payment date, is always a federal holiday.
As an example, for the third quarter of 2016, the average CPI-W was 235.057. For the third quarter of 2017, the CPI-W averaged 239.668. As this represents a 2 percent increase, the COLA for 2018 is also 2 percent.
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Why Cost-of-Living Adjustments Are Critical to You
Cost-of-living adjustments are critical to ensure that recipients do not see their benefits diluted due to the effects of inflation. Even in modest inflationary environments, the purchasing power of money can be significantly impaired. An example can put this principle into sharper focus:
From January 1997 to January 2017, the yearly rate of inflation in the U.S. averaged just over 2 percent. Seemingly, this is a minor change — a haul of groceries costing $1,000 would cost $1,021 the following year. However, over a 10-year period, even a low inflation rate can tremendously increase the cost of living.
Using real-world figures from the Bureau of Labor Statistics, what only took $1,000 to buy in January 2007 would cost $1,199.70 in 2017, or nearly 20 percent more. Without a COLA, you would have effectively faced a 20 percent cut in your Social Security income. Over 20 years — from 1997 to 2017 — your purchasing power would have dropped more than 52 percent.
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History of Cost-of-Living Adjustments
The average cost-of-living adjustment for the past 20 years was 2.10 percent; however, this number can fluctuate dramatically over the years. For 2010, 2011 and 2016 there was no cost-of-living adjustment at all. Contrast this with the high-inflation period between 1975 and 1982, when the annual cost-of-living adjustment was as high as 14.3 percent.
Why Cost-of-Living Adjustments Matter for Social Security
The truth is, no one knows exactly where inflation is headed, which is why the cost-of-living adjustment is so important. What the history of cost-of-living adjustments proves more than anything is that whatever inflation does, your Social Security will be adjusted to help protect your purchasing power.
Projected Social Security Payments From 2019 to 2034
The average benefit check for January 2018 is $1,404. Future payments will be based on COLAs as determined by the Social Security formula. Based on the last 20 years, the average COLA was 2.1 percent. Using that as a baseline average rate, here’s a table showing the anticipated Social Security payments for every year from 2019 to 2034. After 2034, the future of Social Security is currently uncertain.
|Projected Average Social Security Payments: 2019 to 2034|
|Year||Projected Avg. Payment Amount|
Two Components of the Social Security Trust Fund
What is commonly referred to as the Social Security trust fund is actually two funds: the Old Age and Survivors Insurance Trust Fund and the Disability Insurance Trust Fund. By law, these two funds are technically separate entities. The OASI fund is responsible for retirement and survivors benefits and the DI fund pays disability benefits. But the two funds are typically combined for purposes of discussion, particularly regarding the solvency of Social Security.
Future of Social Security Payments After 2034
Social Security payments cannot be accurately projected after 2034 due to the financial state of the Social Security trust funds. As of the end of 2016, things looked great: the Social Security trust funds had asset reserves of more than $2.8 trillion. Further, the trustees of the Social Security trust funds projected that those asset reserves will exceed the annual cost of payouts through 2029.
Starting in 2021, however, it’s projected that the total income paid into the fund will not be sufficient to cover total fund costs.
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Depletion of Social Security Surplus by 2034
Using a highly simplified explanation, revenue raised from Social Security taxes is expected to fall short of the total costs of paying out Social Security benefits. At that point, the excess reserves of the fund will need to be withdrawn. Currently, fund trustees expect that surplus to be depleted by 2034.
What’s Next for Social Security
So, what happens after the Social Security surplus is depleted? Some doomsday commentators have suggested that these figures mean Social Security will be bankrupt in 2034. But that interpretation depends on how you define “bankrupt.”
Although it’s true that the Social Security reserve fund will be depleted, according to current projections the Social Security program will still be bringing in tax revenues from workers every year. These revenues are anticipated to cover about 77 percent of benefit payouts. Although this means Social Security won’t go bankrupt in the sense of stopping payments in 2034, there could very well be benefit reductions.
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About the Author
John Csiszar is a freelance writer and article curator. He served as a registered investment advisor for 18 years before becoming a writing and editing contractor for private clients. In addition to writing thousands of articles for various online publications, he has published two educational books for young adults.