Household inflation pressures collapsed earlier this year as a result of the economic disruptions caused by the coronavirus and related containment efforts. Many Social Security recipients will naturally be worried that this will have severely diminished any chance of seeing another cost of living adjustment (COLA) to their government benefits in 2021. We will not know for certain until the September reading on consumer inflation is released by the Bureau of Labor Statistics, but recent data suggest that the outlook has improved considerably for retirees.
Indeed, annual COLAs are based on the percentage increase (if any) in the average level of the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) for the third quarter of the current year (2020) over the average for the third quarter of the last year in which a COLA became effective (2019). If there is an increase, it must be rounded to the nearest tenth of one percent. If there is no increase, or if the rounded increase is zero, there is no COLA. The CPI-W fell 0.2 percent in March and then another 0.7 percent in April, but managed to hold steady in May as the lockdowns started to be lifted and then in June bounced back by 0.6 percent. Altogether this left the CPI-W at 251.054 at the end of Q2 2020.
Since the CPI-W averaged 250.200 in the third quarter of 2019 that means that even if the CPI-W just drifted sideways in the July through September period there would still be a COLA of 0.3 percent in 2021. That is small compared to the average 2.1 percent COLA seen during the previous three years, but any increase is better than nothing. Further, the “second wave” of the coronavirus might have removed some momentum from the economic recovery but without another wide-scale lockdown it is likely that the reflation trend continued in Q3, meaning that a larger COLA is still a possibility for retirees. Overall, though, the 2021 COLA will likely still be well below the historical average, which some may argue is an encouraging sign that inflation is not quickly eroding retirees’ savings.
However, that is not necessarily true because medical care costs, for instance, typically rise faster than the CPI-W, and often by quite a bit (see above chart). Since retirees are usually older and therefore have a higher likelihood of suffering from health complications, their perceived level of inflation could be a lot more severe than what the CPI-W would suggest. Alternative measures of inflation have been proposed but for younger Americans a clear takeaway should be that long-term participation in a tax-advantaged 401(k) retirement plan and other savings vehicles can help limit their old-age dependence on the government (Social Security), and as a result lower their overall sensitivity to annual COLAs.
Sources: U.S. SSA, U.S. BLS, FRBSL