For the approximately 65 million Americans who are slated to receive benefits from Social Security this year, the state of the Social Security Administration’s funding is an important concern.
For several years, analysts have warned that Social Security was expected to “run out” by 2035 (meaning a significant reduction in benefits, not that the funds would be cut down to zero). The expected cost of living increase or COLA (cost-of-living adjustment) is calculated based on the Consumer Price Index and is intended to help counteract inflation.
Why Social Security increases most years
Social Security is funded through a payroll tax, which means that employees and employers pay a set percentage. Then at retirement age, individuals who have been paying into the system can start taking benefits (payments) depending on their age and how much they have contributed throughout their career.
Most years, the benefits adjust to keep up with inflation rates (aiming to give recipients equivalent buying power as inflation rises). This adjustment, or COLA, started in 1975 and is based on the Consumer Price Index. In October of 2020, the Social Security Administration declared a 1.3 percent COLA. The next cost-of-living increase will be announced in October 2021.
Social Security's impact of inflation
Each year, inflation impacts the benefits paid out by Social Security since it directly affects how much benefits increase, if at all. The inflation rate over the past year has been about 5.4 percent, which might lead to higher Social Security benefits. Some estimates put the COLA for 2022 at over 6 percent.
An issue with the cost-of-living increases and inflation is that Social Security is required to only invest its funds in U.S. Treasuries, which don’t keep pace with inflation.
If the COLA for Social Security in 2022 is at 6.1 percent or greater, it would be the largest increase in Social Security payments since 1983, according to the Senior Citizens League.
A Congressional bill introduced in July, the Fair COLA for Seniors Act of 2021 proposes changing the measure used to calculate COLA. Instead of the Consumer Price Index for urban wage earners and clerical workers (CPI-W), it would use the CPI-E, based on pricing for the elderly to more accurately reflect retirees’ needs.
Why Social Security is in trouble
For several years now, experts on the Social Security system have been warning that the program won't be able to sustain itself forever. It’s largely a population problem—when you have more money being paid out than is being brought in through payroll taxes, the benefits can’t continue at the expected level.
As the number of retirees has increased along with life expectancies, the Social Security funds have been increasingly stressed.
The Old Age and Survivors Insurance (OASI) Trust Fund of Social Security is projected to be able to pay benefits on time and in the anticipated amounts until 2034. This fund, which pays benefits to retirees and survivors, will then have to reduce benefits to about 76 percent of the full benefits scheduled.
The COVID-19 pandemic and rising inflation rates could cause additional strain and move up the timeline of when Social Security is forced to reduce benefits.