Uh-oh! Social Security benefits may not increase much after all in 2018

Social Security is a critical source of income for many of the nearly 42 million retired workers receiving a monthly benefit check. Data from the Social Security Administration shows that more than three in five retired workers receiving benefits relies on their monthly check to account for at least half of their income. Without that income, we'd probably be talking about millions of additional senior citizens living below the poverty line and struggling to make ends meet.

Of course, this vital program for tens of millions of retirees is also a source of frustration and angst. According to the latest annual report from the Social Security Board of Trustees, the program is on track to burn through its nearly $3 trillion in asset reserves by 2034, which is the same forecast as issued in its 2016 report. Should Social Security burn through this excess cash, an across-the-board cut in benefits of up to 23% may be needed to extend the solvency of the program through the year 2091. It's not a particularly rosy outlook for those who rely on Social Security to make ends meet.

The purchasing power of Social Security benefits is shrinking

Yet this is far from the only issue that seniors are facing. In addition to an imminent crossroads for Social Security in 2034, seniors are also contending with less-than-spectacular cost-of-living adjustments, or COLA. COLA is the "raise" that Social Security beneficiaries receive most years that accounts for inflation.

In a perfect world, seniors receive an increase in their monthly payout that's commensurate with the aggregate inflation that they're facing. Unfortunately, reality is nothing close to the "perfect world" example. For instance, over the past eight years, COLA has totaled 0% three times, and just 0.3% for 2017, the lowest increase on record. This means that while seniors are receiving very little in the way of Social Security "raises," the cost of housing and medical care continues to rise. In fact, not counting 2017, medical care inflation has outpaced Social Security's COLA in 33 of the past 35 years. In other words, the purchasing power of Social Security benefits is shrinking.

The Board of Trustees predicts a 2.2% COLA for 2018

The inflationary tether that helps determine how much of a raise seniors will receive from one year to the next is the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The average reading for the third quarter of the previous year (July through September months) serves as the baseline figure, while the average reading from the third quarter of the current year acts as the comparison. An increase in the CPI-W year over year is passed along to beneficiaries as a percentage and rounded to the nearest 0.1%. A decrease in the CPI-W year on year, which has happened three times since the Great Recession, leaves benefits static. Thankfully, Social Security benefits can't drop because of deflation.

Last month, the Social Security Board of Trustees projected that the CPI-W was on track to gain 2.2% this year. Should 2.2% be the final COLA for 2018, it would be the largest increase beneficiaries have seen in six years. 

Not so fast! 2.2% may be wishful thinking.

However, if I were a Social Security recipient, I wouldn't go counting those chickens just yet. According to the July inflation data release from the Bureau of Labor Statistics (BLS) on the morning of August 11, the CPI-W wound up dropping another 0.1% on an annualized basis to a rate of 1.6% for the 12-month period. 

Again, it's worth pointing out that these figures do regularly change from month to month. However, it's also hard to ignore that the Consumer Price Index for all Urban Workers (CPI-U), a similar measure to the CPI-W, has fallen in every month but one since February and has regularly come in below economists' expectations over that time span. In essence, lower inflationary figures could spell yet another subpar COLA for seniors come 2018.

Why the lag in inflation? According U.S. city data provided by the BLS for the CPI-U, food and energy have been the inflationary saviors, with unadjusted trailing-12-month inflationary increases of 1.1% and 3.4%, respectively. On the other hand, new and used vehicle sales and apparel have dragged down the CPI-U.

With the average retired worker bringing home $1,368.67 a month in June 2017, according to the SSA, a 2.2% COLA would translate into an extra $361.33 a year in 2018, or $30.11 a month. But if the current 1.6% increase, based on the July BLS reading, were to hold, seniors would get only an extra $21.90 a month, or $262.78 next year. All the while, the cost of medical care commodities is up 3.7% over the trailing-12-month period, according to BLS data.

25 Social Security facts & figures you need to see
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25 Social Security facts & figures you need to see

1. 60.66 million

As of the September 2016 snapshot from the Social Security Administration (SSA), 60.66 million people were receiving monthly benefits, two-thirds of whom are retired workers. A little more than 6 million survivors of deceased workers and 10.6 million disabled persons were also receiving monthly benefits.

(Caroline Purser via Getty Images)

2. 5.44 million

Social Security's beneficiary base is increasing rapidly due to the ongoing retirement of baby boomers, which is expected to last until about 2030. As such, 5.44 million people were newly awarded Social Security benefits in 2015. 

(ImagesBazaar via Getty Images)

3. $1,300

It's important to understand that Social Security isn't an entitlement, though the requirements for a guaranteed benefit are not too high. You need 40 lifetime work credits to qualify for Social Security benefits, and a maximum of four credits can be earned annually. In 2017, one work credit is equal to $1,300 in wages. Simply earn $5,200 in 2017 and you'll have maxed out your work credits for the year. Do that 10 times and you'll be guaranteed benefits when you retire.

4. 96%

Based on statistics from the SSA, nearly all working Americans (96%) are covered by survivors insurance protection. Though Social Security is primarily designed to provide financial protection for retired workers, it does provide benefits for the spouses, children, and in rarer cases parents of deceased workers.

5. 90%

To add to the above statistic, the SSA also points out that 90% of the American workforce is covered in case of long-term disability. Since nearly 70% of all private sector workers have no long-term disability insurance, it's good knowing that Social Security has their back.

6. 55%

An interesting figure from the SSA is that 55% of beneficiaries are women. Social Security income is of particular importance to women since 1) they tend to live about five years longer than men, on average, and 2) they're often the caregivers that take care of the kids or sick family members, thus their lifetime earnings are often lower than their male counterparts'. Social Security income can be critical to ensuring a healthy financial foundation for women come retirement.

7. 32%

According to an analysis conducted by the Center on Budget and Policy Priorities (CBPP), Social Security income has reduced what would be a 40.5% poverty rate for seniors without this added income to just 8.5%. While the CBPP's analysis can't factor in external variables such as how much extra seniors would have saved prior to retiring if Social Security wasn't available, it's clear as day that Social Security is critical to keeping seniors on solid financial footing. 

8. 81%

Based on data from the SSA, 81% of all benefits paid out by the Old-Age, Survivors, and Disability Insurance Trust (OASDI) are heading to seniors ages 62 and up. Just 5% go to children under the age of 18, and another 14% to adults between the ages of 18 and 61.

9. 61%

Statistics from the SSA in 2016 show that 61% of seniors rely on Social Security to provide at least half of their monthly income. For elderly couples this figure was 48%, while 71% of unmarried elderly persons lean heavily on the program for at least half of their monthly income.

10. $920.2 billion

The SSA's data showed that $920.2 billion was collected from three revenue channels in 2015. A majority of this revenue came from payroll taxes (86.4%), while interest earned on the OASDI's spare cash (10.1%) and the taxation of benefits (3.4%) comprised the remainder.

11. 12.4%

Payroll taxes comprise the lion's share of revenue collection for Social Security. This tax totals 12.4% of wages (up to a certain point, which is discussed below) and it's typically split down the middle between you and your employer, with each paying 6.2%. If you happen to be self-employed, you're on the line for the entire 12.4% tax.

12. $127,200

There is, however, a cap on how much a person can be taxed by the SSA via the payroll tax. All earned income in 2017 between $1 and $127,200 is subject to the 12.4% payroll tax. Any wages beyond that point are free and clear of being taxed by the SSA.

13. $1,351.70

The September 2016 snapshot shows that the average retired worker is bringing home $1,351.70 per month, or $16,220 over the course of a year. Annual benefit increases are tied to the inflation rate as measured by the Consumer Price Index for Urban Wage Earners and Clericals Workers, or the CPI-W. 

14. 0.3%

Speaking of inflation, Social Security beneficiaries are getting a 0.3% cost-of-living adjustment (COLA) in 2017, the smallest increase on record. Social Security's COLA has been dragged down in recent years by weaker energy and food costs, which are sizable components of the CPI-W.

15. 33 out of 35 years

One of the more saddening facts and figures about Social Security is that its COLA has been lower than medical cost inflation in 33 of the past 35 years. The CPI-W factors in a number of varied expenses, but medical costs are a much smaller portion of workers' average expenditures. Seniors spend double what urban wage earners and clerical workers do on medical costs as a percentage of their annual expenditures.

16. $2,687

Social Security benefits are capped at $2,687 per month, which makes sense given that payroll taxes have an annual cap as well. The monthly benefit cap is usually adjusted year-to-year based on inflation. Only a small fraction of Americans have a shot at reaching this maximum payout, as you'll see in the next figure.

17. 60%

Based on data from 2013, as assembled by the Centers for Retirement Research at Boston College, 60% of retirees sign up for benefits before reaching their full retirement age (FRA). A person's FRA is when they become eligible to receive 100% of their FRA benefit. By signing up early, retirees are taking a cut in benefits from their FRA benefit of up to 25% to 30%.

19. 2.8-to-1

As of 2015, the worker-to-beneficiary ratio stood at 2.8 workers for every one beneficiary. In about two decades, this ratio is forecast to drop to 2.1-to-1. In simpler terms, baby boomers are retiring in increasing numbers, and there simply aren't enough new workers to take their place and maintain the worker-to-beneficiary ratio at its current level. This leads to the next point...

20. The year 2020

Based on the latest report from the Social Security Board of Trustees, by 2020 the cash inflow into the OASDI is slated to turn into a cash outflow. In other words, what's expected to be close to $2.9 trillion in spare cash will begin dwindling in 2020.

21. The year 2034

Perhaps the scariest finding of the Trustees' report is that Social Security's spare cash is expected to be exhausted by the year 2034. Assuming Congress passes no new laws affecting Social Security, the Trustees predict that an across-the-board benefits cut of up to 21% may be needed to sustain payouts through the year 2090.

22. 2.66%

Findings from the Board of Trustees report also showed that the actuarial deficit in 2016 was 2.66% for the program. In easier-to-understand terms, a 2.66% increase to the payroll tax would be expected to alleviate all funding concerns through the year 2090. This would mean an increase to 7.53% if you're employed by someone else, or 15.06% if you're self-employed.

23. 56%

It's a fact that gets overlooked by many seniors, but Social Security income may be taxable. Individuals earning more than $25,000 annually and joint filers with income over $32,000 could have a percentage of their Social Security benefits taxed. Not to mention 13 states also tax Social Security benefits.

24. 51%

According to Gallup, 51% of polled Americans in 2015 believed Social Security won't be there for them when they retire. Luckily, this is blatantly false. Social Security is essentially incapable of going bankrupt because it'll always be collecting payroll tax revenue from the workforce. Benefits may indeed need to be cut, but the program will be there for many generations to come.

25. 28%

Finally, a survey conducted by MassMutual Financial Group in 2015 found that just 28% of the more than 1,500 respondents who took its quiz received a passing grade and correctly answered at least 7 out of 10 multiple choice or true/false questions. Only 1 respondent out of more than 1,500 got all 10 questions correct. It's a stark reminder of just how little Americans know about Social Security.


Seniors needs more, but the program can't afford more

A recent history of low or nonexistent COLAs touches on a pretty big issue for Social Security. Seniors needs larger COLAs to more accurately reflect the medical-care inflation and housing expenditure costs they're facing relative to younger working Americans. Yet these younger workers help define inflation for the CPI-W.

One proposal that's made its rounds in Washington is the idea of replacing the CPI-W with an inflationary measure that focuses strictly on households with seniors: the Consumer Price Index for the Elderly (CPI-E). With added emphasis on medical care and housing expenses, and lower emphasis on other spending categories like education, apparel, and entertainment, the idea is that the CPI-E would get seniors a bigger annual COLA by focusing more specifically on their financial needs. And there's little argument that seniors need larger annual COLAs.

However, there's that little problem of Social Security's imminent budgetary shortfall of $12.5 trillion between 2034 and 2091. Adjusting to the CPI-E from the CPI-W would mean burning through the existing asset reserves even faster and putting the program on a more imminent collision course with possible benefit cuts.

Congress clearly needs to do something before it's too late.

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