The 8.7% increase in Social Security in 2023 could be as big as it gets

(Bram Berkowitz)

After months of anticipation, retirees now know that their Social Security benefits will officially increase by 8.7% in 2023, due to the largest cost of living adjustment (COLA) in more than 40 years.

In September, the average monthly Social Security check for retirees was $1,628.17, which means that next year retirees could see their monthly benefits increase by more than $141, which equates to an increase over $1,692 annually.

The increase is badly needed given the high level of inflation this year, which has driven up the cost of goods and services everywhere from the pump to the grocery store. While the large increase is welcome news, it could also be the largest annual increase in Social Security benefits in some time. Here’s why.

How COLA is calculated

Each year, the Social Security Administration (SSA) increases retiree benefits to account for inflation, which raises the cost of living. This is called the COLA adjustment.

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To calculate the COLA increase, the SSA looks at inflation using data from the Consumer Price Index for Urban and Office Workers (CPI-W). This index tracks and measures price changes on a basket of consumer goods and services for items purchased by urban wage earners and office workers in various regions of the United States.

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Specifically, the SSA looks at the CPI-W during the third quarter of the year, which includes the months of July, August and September. To calculate the COLA, the SSA takes the average CPI-W in the third quarter of the year and then compares it to the average CPI-W for the same period of the previous year. The percentage difference determines the COLA for the following year, although benefits can never be decreased.

The main thing to understand here is that the COLA is highly dependent on inflation, so if there is a lot of inflation one year, you can probably expect a big increase in the COLA the next year.

Inflation is expected to peak soon

You wouldn’t know it from looking at recent inflation data, but most experts expect inflation to peak soon and consumer prices to rise at a slower pace than what we’ve seen. This year.

A closely watched survey by the University of Michigan showed that consumers expect prices to rise 5.1% in one year and 2.9% over the next five years. These expectations have actually increased since September and represent a strong dose of continued inflation, but it’s still not as much inflation as we’ve seen this year.

This University of Michigan survey, however, is not the only group that expects the pace of inflation to slow in the coming years. The International Monetary Fund forecasts global inflation to be 6.5% in 2023 and 4.1% in 2024.

The research firm the morning star also expects inflation to decline over the next few years. Looking at the Personal Consumption Expenditure (PCE) price index, the Federal Reserve’s favorite inflation gauge, Morningstar expects the PCE to rise 5.9% in 2022, but grows on average by only 1.5% between 2023 and 2026.

Future COLAs could still be decent

One of the reasons so many economists and pundits expect inflation to slow in the near future is that the Fed has now aggressively raised interest rates and may continue to do so. later this year.

These, by design, should lower prices by making things like mortgages more expensive and therefore reducing demand, which over time tends to cool prices. Given that the Fed has raised interest rates so much in such a short time, economists expect to see a cooling effect at some point — but that may take a while to materialize.

That’s why I don’t think inflation will rise as much as this year anytime soon, that’s why I don’t expect to see another 8.7% increase in Social Security COLA anytime soon. COLA futures could continue to be above average for the next few years, although it would ultimately be good for most people’s finances right now if inflation slows.

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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.

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