The Strange Reason Social Security's 2020 COLA Could Be Higher Than Expected
Sean Williams, The Motley Fool
Updated
When it comes to Social Security, there's perhaps no figure more closely monitored by its 63 million-plus current beneficiaries than the annual cost-of-living adjustment, or COLA.
Think of COLA as the "raise" passed along to beneficiaries that's designed to allow them to keep up with inflation (i.e., the rising cost of goods and services). Each year, during the second week of October, the Bureau of Labor Statistics (BLS) releases its September inflation report, providing the final puzzle piece for the Social Security Administration to calculate what sort of raise, or COLA, beneficiaries will be receiving in the coming year.
Since 1975, Social Security's COLA has been tied to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W has eight major spending categories, but dozens upon dozens of subcategories, each with their own various weightings. When the BLS reports inflation data during the second week of each month for the preceding month, it also reports an aggregate CPI-W reading that can be used by anyone to determine COLA.
Here's the interesting aspect of the COLA calculation: Only months in the third quarter count. This means the CPI-W readings for July, August, and September will be used to calculate COLA for the upcoming year, with the other nine months not factoring into the calculation at all.
In order to calculate COLA, you simply need the average CPI-W reading from the third quarter of the current year (add up July's, August's, and September's CPI-W reading, then divide by three), and the average reading from the third quarter of the previous year. If the current year reading is higher, beneficiaries will receive a raise commensurate with the percentage increase, and rounded to the nearest 0.1%. As I said, you don't need an advanced math degree to calculate Social Security's COLA on your own.
Two clenched fists squaring off, one decorated as the American flag, and the other decorated as China's flag.
Image source: Getty Images.
Social Security's 2020 COLA could come in way ahead of estimates for a surprising reason
So, what might the 2020 COLA hold in store for beneficiaries? Keeping in mind that we're still a few weeks from even entering July, the first month that actually counts toward the COLA calculation, there are two published COLA estimates.
Mary Johnson, senior policy analyst at The Senior Citizens League (TSCL), has forecast a 1.7% COLA for 2020, which doesn't sound like much, but would actually be one of the largest increases over the past decade. Considering that the average retired worker was bringing home $1,468.39 a month as of April 2019, a 1.7% COLA would increase their benefit check by roughly $25 a month, or $300 a year.
The other published projection actually from the Social Security Board of Trustees report. On page 115 of the more than 260-page report, the Trustees' intermediate-cost model forecast a 1.8% COLA in 2019 (meaning for the 2020 year). Keep in mind that the Trustees report is generated weeks or months in advance of its release, which in 2019 was early April. That makes the Trustees report more of a guess than any of the estimates you might come across.
But what you may not realize is that both of these COLA estimates may be understating the raise that awaits beneficiaries next year. That's because tariffs associated with the U.S.-China trade war, and perhaps even the recently announced tariffs on imported goods from Mexico, could provide an upward lift on the price of goods imported into the United States.
The purpose of tariffs is to promote domestically made products. In other words, it's President Trump's way of coercing Americans to buy American-made goods. But if consumers choose to continue buying imported goods from China or Mexico, they'll pay a higher price for those items. This higher price will be recognized by the CPI-W and may very well translate into a higher-than-expected COLA in 2020.
A visibly worried senior man drinking from a mug, with a stack of bills laid in front of him on a table.
Image source: Getty Images.
A higher COLA isn't necessarily cause for celebration
Technically, tariffs aren't the only oddball factor that can impact Social Security's COLA. Since the calculation is based on third-quarter CPI-W readings, this is right in the middle of hurricane season. Hurricanes have been known to disrupt the energy industry in the Gulf of Mexico, or refineries along the East Coast, pushing fuel prices higher, and bumping up COLA.
But a higher-than-expected COLA isn't necessarily cause for celebration. That's because if COLA is moving notably higher, the price of goods that seniors are buying is probably rising at a faster pace, too.
This is an important point to keep in mind: COLA isn't designed to help beneficiaries get ahead. Rather, it was designed as a tool to keep beneficiaries on par with the rising cost of goods and services. Therefore, a higher COLA doesn't mean "getting ahead" -- it simply means that beneficiaries are contending with higher inflation.
This is bad news, because seniors have consistently seen the value of their Social Security dollars erode over time. This is the result of the CPI-W doing a poor job of accounting for the costs that actually matter to elderly Americans.
As noted earlier, the CPI-W measures the spending habits of urban and clerical workers, who have markedly different spending habits than senior citizens. As a result, important costs to seniors, such as housing and medical care, tend to be underrepresented in the COLA calculation, while less-important expenses, such as education, apparel, and transportation, bear higher weightings. The end result, based on an analysis by TSCL, is that seniors have seen 33% of their Social Security purchasing power disappear since the year 2000.
So, yes, Trump's tariffs against China and Mexico might result in a bigger "raise" in 2020 for Social Security recipients, but that doesn't necessarily mean those recipients will be keeping up with the true inflation they're facing.
