2020 COLA revealed; how it affects your pension

Sean Williams, The Motley Fool
Published 09:00 on October 12, 2019


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The big day has finally arrived!

Given that 62% of retirees work with at least half of the income from social security, all eyes were on October 10. That's because October 10 is the release date for the U.S. Bureau of Labor Statistics (BLS) inflation data for September, which contains the latest puzzle needed to calculate Social Security's Cost of Living Regulation (COLA) for 2020.

Simply put, COLA is the "increase" which the recipients receive from one year to the next that takes into account the inflation they have encountered. Of course, it is not an increase in the worst sense of the word, because COLA is only designed to keep up with inflation, not exceed it.

The BLS report from September's inflation data allowed the specific announcement that Social Security's COLA in 2020 will increase by 1.6%.

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How Social Security's COLA was Determined

How did the Social Security Administration live in this figure? I can assure you that it was not picked out of thin air when it was back in the 1950s. Rather, Social Security's COLA is tied to the Consumer Price Index for Wage and Town Salaries (CPI-W), and has been around since 1975. CPI-W has eight major spending categories and a plethora of subcategories, each with their own respective weightings that help to Determine the movement in the price of a predetermined basket of goods and services.

Perhaps the most interesting aspect of the COLA calculation is that very few monthly CPI-W measurements are actually used. Only measurements from the third quarter (July to September) are included in Social Security's COLA. The remaining nine months, although potentially useful in identifying price trends, are not used in the calculation process.

To determine the following year's COLA, the Social Security Administration simply takes the average third-quarter CPI-W reading of the current year and compares it with the average third-quarter reading the previous year. If the average has risen from one year to the next, it means that inflation has taken place. In such a case, the recipients will receive a "raise" that corresponds to a percentage increase from year to year, rounded to the nearest tenth percent.

In the rare event that reading declines from one year to the next, signaling deflation, the benefits remain static. This has only happened on three occasions (2010, 2011 and 2016) since CPI-W became Social Security's inflation target.

What does this mean for recipients of Social Security?

Now let's put this metric to life and see how it's going to affect Social Security's nearly 64 million recipients.

In 2018, CPI-W's third-quarter readings were as follows:

  • July: 246,155
  • August: 246,336 [19659020] September: 246,565

And in 2019 CPI-W's Third Quarter Measurement:

  • July: 250.236
  • August: 250.112
  • September: 250.251

As you can see, average CPI-W reading is in the third quarter of this year, 250,200, higher than the average CPI-W for the third quarter of the previous year, 246,352. This means that recipients will receive a payout increase in 2020.

The extent of this commitment is determined by subtracting the average CPI-W reading in Q3 2018 from the average CPI-W reading in Q3 2019, and then divide the remaining value (3,848 points) into average CPI-W reading in Q3 2018 to determine the percentage increase, rounded to the nearest 0.1%. That's how the Social Security Administration came to a COLA of 1.6% in 2020.

What does this mean for the social security recipients' wallets? Based on the fact that the average retired worker and the disabled worker fetched $ 1,473 and $ 1,236 respectively, a month from August, a 1.6% COLA would lead to an increase of around $ 24 a month for retirees and just under $ 20 a month for the long-term disabled.

To draw defeat from victory jaws

On the one hand, there is good news that Social Security benefit recipients will receive a cooler monthly payment in 2020. But the reason for the celebration is somewhat muted when you consider the fact that COLA regularly has not kept up with the actual inflation rate that the elderly have struggled with since the turn of the century.

According to an analysis by The Senior Citizens League, the purchasing power of Social Security dollars for the elderly has fallen by 33% since the beginning of 2000. In simple terms, it means that retired workers could buy with $ 100 in Social Security income in 2000 now will buy only $ 67 worth of the same goods and services.

The problem is that CPI-W just doesn't do a good job of measuring the costs that matter to retired workers. That's because, as the index's name suggests, it is linked to the habits of urban and clerical workers, who happen to spend their money very differently from retirees. CPI-W thus ignores that over 62 years of age make up more than four of five relevant program recipients. This leads to an underweight of really important expenses, such as medical care and housing, and an overweight of less important costs for the elderly, such as education, clothing and transport.

Despite legislatures from both political parties in Washington, the CPI-W agreed that they were wrong, and also failed to find common ground for resolving these issues. As a result, no matter how large or small of a COLA is transferred to Social Security benefits recipients each year, there is still a very good chance that it will still be insufficient to cover the true inflation that pensioners are actually struggling with.


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