The coming hefty Cost of Living Adjustment for Social Security, and other benefits of inflation
One of the scariest financial stories of 2021 has been the return of inflation, but for retirees, there’s a significant upside to this: The Social Security cost of living adjustment (COLA) could be as high as 6% or more for 2022, according to estimates from outfits ranging from Moody’s Analytics to the Senior Citizens League. That would be the biggest increase since 1983, when the adjustment rose by a whopping 7.3%.
The final COLA for 2022 will be released in October of this year. The Social Security Administration calculates the COLA by figuring the percentage increase in the rate of inflation from the third quarter of the current year to the third quarter of the previous year. The latest COLA, taking effect in January 2021, was just 1.3%.
To figure its adjustment, Social Security uses the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W, as opposed to the more standard Consumer Price Index or CPI. It places a slightly higher weight on food, apparel, and transportation and a lower one on housing and recreation, than the standard CPI. Gasoline is particularly heavily weighted in the CPI-W, which is one reason this measure has jumped so noticeably during 2021.
In addition, since many consumer items fell in price during the thick of the pandemic a year ago, the inflation adjustments are proceeding from a lower baseline than normal. Over the 12 months from June 2020 to June 2021, CPI-W rose 6.1%, a smidgen ahead of the benchmark CPI, which rose 5.4% over that period.
While this year’s rising inflation has alarmed many people, the increase in the Cost of Living Adjustment shows one of the ways in which inflation can be beneficial. Some of the other ways in which inflation might be making your financial life a little more comfortable:
- Fixed-rate debt, such as your mortgage, becomes financially advantageous to you when your inflation rate exceeds the mortgage rate. Let’s say inflation is rising at 4.5% per year, while you have a mortgage with a 3.5% interest rate. The value of your home is likely to be increasing at a higher rate than the interest you’re paying on it. In other words, the nominal cost of your interest payments has become negative.
- Some sectors of the stock market are correlated with inflation, which means that as prices go up, their share prices tend to go up as well. Energy stocks and industrial stocks, connected as they are to hard assets, are two sectors that generally do well in inflationary times.
- You have a greater potential to negotiate raises at work. Not only can you justify asking for more money to pay higher prices for the goods and services you need, inflation tends to come in times of tight labor markets, as we seem to be experiencing today. This tips the leverage in negotiations over to the worker.
- Inflation can also be an overall positive for the economy. When people fear that prices will be higher in the future, they spend on goods and services now – and since consumer spending constitutes about 70% of the economy, that fuels economic growth.
Rising inflation can have an effect on many different aspects of your financial life. To understand how it might affect your particular situation, reach out to your Baird Financial Advisor team.
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