Inflation and Social Security


Inflation is measured by the Consumer Price Index (CPI; see the official definitions at the end of this blog), which tracks hundreds of goods and services year over year, to determine if there is an increase, decrease or no change to the purchasing power of a dollar. If there is an increase, then you’ll need more dollars to buy the same goods and services going forward.

Even social security makes adjustments every year for this cost-of-living adjustment (COLA) or inflation factor, although for 2021, that increase was only 1.3%. With that in mind, if inflation were to continue at a higher rate, will Social Security increase at a similar rate for 2022?

Looking at inflation changes so far in 2021, the increase could exceed 4% in 2022. If so, this increase would be the biggest since 2008, when recipients received a 5.8% bump up in retirement income on their Social Security.

The key to all of these numbers will be determined in the third quarter of 2021. Social Security’s employees don’t audit the spending habits of retirees. They instead look at something called the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The monthly results for the third quarter of the current year are compared to the third quarter of the prior year. The difference in this CPI-W factor is what determines how much Social Security will increase. If there is no difference, then no increase is awarded.

The recent March through May three-month period of 2021, compared to the same period in 2020 is nearly 4.4% higher. If this data was actual third quarter data, Social Security recipients would be receiving a 4.4% increase. We’ll have to wait until the actual 2021 third quarter results come out to determine what the real increase will be.

That being said, the Federal Reserve’s recent projections suggest a big increase is possible. On June 16th, the Central Bank boosted its gross domestic product, or GDP, outlook to 7% — the highest rate since the 1980s — and upped its inflation estimate for this year to 3%, excluding volatile food and energy prices, up from 2.2% in March.

If inflation remains high in the third quarter, then the total dollar increase in your Social Security benefit might not be too exciting, though. The average retired worker is collecting $1,554 per month in 2021, according to Social Security’s statistical snapshot in May, and that means a 4.4% increase will translate into only about $74 per month in extra income for the average retiree.

Certainly, no one will complain about an additional $74 per month in income, but that’s unlikely to dramatically change your lifestyle for most people. Remember, it’s not a pay raise if the cost of goods and services you purchase continue to go up. It only keeps you “even” with the purchasing power of a dollar.

Having a financial plan in place to use as a benchmark for your retirement cash flow and investment strategy will better align your goals with inflation. For example, if you were to buy a 5-year bond or CD that’s paying 1% over the next 5 years, it’s easy to see now that you’re losing money if inflation is rising at 4.4%. More than likely an investment strategy of both bonds and stocks will help you better prepare for inflation and lead an amazing retirement with financial freedom.

Key Definitions:

What is inflation?
Inflation is described as continuously rising prices, or the continuous fall in value of the dollar.

What is core inflation?
Core inflation is a measure of inflation that excludes certain items known for their volatility, like food and energy prices.

What is the Consumer Price Index (CPI)?
The Consumer Price Index, also referenced as CPI, is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

Is the CPI the best measure of inflation?
This perhaps is best addressed by the Bureau of Labor Statistics (BLS) who creates the CPI. This is directly from their website:
Various indexes have been devised to measure different aspects of inflation. The CPI measures inflation as experienced by consumers in their day-to-day living expenses; the Producer Price Index (PPI) measures inflation at earlier stages of the production and marketing process; the Employment Cost Index (ECI) measures it in the labor market; the BLS International Price Program measures it for imports and exports; and the Gross Domestic Product Deflator (GDP Deflator) measures combine the experience with inflation of governments (Federal, State and local), businesses, and consumers. Finally, there are specialized measures, such as measures of interest rates and measures of consumers’ and business executives’ expectations of inflation.
The “best” measure of inflation for a given application depends on the intended use of the data. The CPI is generally the best measure for adjusting payments to consumers when the intent is to allow consumers to purchase, at today’s prices, a market basket of goods and services equivalent to one that they could purchase in an earlier period. The CPI also is the best measure to use to translate retail sales and hourly or weekly earnings into real or inflation-free dollars.

How are CPI prices collected?
The Bureau of Labor Statistics (BLS) has data collectors called economic assistants who are responsible for visiting or talking to various goods and services providers across the United States. According to the BLS, the economic assistants record a scientific sampling of prices on about 80,000 items (goods and services). They gather, record, and update the data monthly, which serves to track and measure price changes in the Consumer Price Index (CPI).

Does the CPI reflect my spending habits or experience with price change?
Not necessarily. For example, the Consumer Price Index does not include spending habits for anyone living in rural areas, those in the Armed Forces, or those in institutions, like prisons.

What goods and services does the CPI include?
The BLS has created more than 200 categories for all goods and services they track. These 200 are placed within eight major groups:

  • Food and Beverages: meat, milk, beer, wine, snacks, etc.
  • Housing: rent of primary residence, owners’ equivalent rent, fuel oil, bedroom furniture, etc.
  • Apparel: clothing like pants, shirts, sweaters, etc.
  • Transportation: vehicles, airline fares, gasoline, etc.
  • Medical Care: hospital services, drugs, medical supplies, glasses, etc.
  • Recreation: TV, pets, movies, etc.
  • Education and Communication: college costs, telephone services, computer software, postage, etc.
  • Other: smoking products, haircuts, and other personal services

The CPI does not include savings or investment items, like stocks and bonds or real estate.
For each of the more than 200 categories, the BLS has chosen several hundred specific items to track as sample points in their data.

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