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Will Social Security Change the Way it Calculates Raises? Here's Why It Should

After years of stingy cost-of-living adjustments, or COLAs, it's finally looking like seniors on Social Security will be in line for a big raise in 2022. That's because inflation has been unusually high over the past few months. If that trend continues into the next part of the year, it could result in a substantial boost to retirees' benefits come January.

But while a nice annual benefit check boost may seem like a good thing, many experts agree that the way Social Security raises are calculated is flawed.

How should you measure inflation?

For years, Social Security COLAs have been calculated based on third-quarter figures from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). When the CPI-W indicates that the overall cost of a basket of common goods and services has risen, benefits get a boost.

Social Security card

Image source: Getty Images.

But there's a big problem with using the CPI-W for that calculation, and it's the whole "urban wage earners and clerical workers" aspect. Retirees are not, as a rule, urban wage earners or clerical workers. As such, the costs that most heavily influence the CPI-W don't accurately reflect the things seniors tend to spend the most money on.

Take gasoline, for example. If you don't work full-time anymore, it's fair to bet that, generally speaking, fuel will be a more minor expense for you than it is for the average worker with a daily commute. But each year, the price of gasoline plays a big role in determining whether seniors wind up with a COLA, and how large that COLA is, even though gas is not something retirees typically spend a lot on.

By contrast, older people tend to need more healthcare than the average working-age American. But as a factor in the CPI-W, medical costs are underweighted relative to how much of their money seniors spend on them.

So what's the solution? The most obvious one boils down to using a more appropriate index to calculate COLAs -- the Consumer Price Index for the Elderly (CPI-E).

Between 1982 and 2011, the CPI-W grew at an annual average rate of 2.9%, whereas the CPI-E grew at a rate of 3.1%. Now, that spread may not seem all that substantial. But those small annual differences add up over the years. Seniors today would be receiving appreciably larger monthly checks if the CPI-E had been used to determine what Social Security's annual COLAs looked like.

The CPI-E, as the name implies, is a senior-centric index. So it would make sense for it to be used in the context of adjusting benefits that are earmarked for seniors specifically.

Some lawmakers have been pushing for this change for years -- to no avail. At the same time, Social Security checks have been losing real buyer power for the past several decades.

Come 2022, Social Security recipients may find themselves more than satisfied with the COLA they receive. But that doesn't negate the fact that sticking to the CPI-W does seniors a major disservice.

One big reason inflation is rampant right now is that the pandemic wrought havoc on global supply chains and disrupted a lot of economic activity. The impact of that continues to ripple around the world. But now, as many people and businesses are trying to get back to something like their former normal behaviors, businesses are finding it hard to readjust fast enough to keep up with reviving consumer demand.

Once that situation normalizes, inflation could fade again and COLAs could easily return to their formerly stingy levels, leaving seniors who rely heavily on Social Security to watch the real value of their monthly benefit checks steadily erode again.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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