Social Security's 2020 COLA Could Be in Big Trouble

As we prepare to turn the calendar on 2018, Social Security recipients are on the verge of receiving their largest cost-of-living adjustment (COLA) in seven years at 2.8%. For the average retired worker, we're talking about an increase in monthly pay of about $40, or $480 on an annual basis. Having received no COLA in 2010, 2011, and 2016, and the smallest increase in history in 2017 of 0.3%, it's a welcome change.

Unfortunately, that change may not last very long, and beneficiaries may have to prepare for another minimal or nonexistent COLA by the time 2020 rolls around.

How your Social Security COLA is calculated

As a refresher, COLA has been determined since 1975 by the Consumer Price Index for Urban Wage Earnings and Clerical Workers (CPI-W). This is an index that measures the change in price for goods and services in eight major spending categories, which themselves have dozens upon dozens of subcategories.

Here's how it works: The average CPI-W reading from the third quarter of the previous year (July through September) acts as the baseline reading, while the average CPI-W reading from the third quarter of the current year serves as the comparison. If the average CPI-W reading rises year over year, then Social Security beneficiaries receive a "raise" in the following year that's commensurate with the percentage increase, rounded to the nearest 0.1%. If the average CPI-W reading declines from one year to the next, then benefits remain static (i.e., no COLA). Thankfully, benefits cannot be reduced due to deflation.

This year, COLA received a big boost because of two key categories: energy and shelter. Crude oil prices roared to a more than four-year high, pushing up prices at the pump and increasing fuel oil costs. Meanwhile, the cost to rent or own a home also increased, with inflation of more than 3%. These two categories proved crucial to netting the largest COLA in seven years. But things could be markedly different for your 2020 COLA.

You may need a magnifying glass for your 2020 COLA

With the understanding that there are countless variables that could change between now and the months that actually matter (July, August, and September), the inflation outlook for 2019 isn't remotely as rosy as it was for 2018 -- and that's bad news for Social Security beneficiaries.

West Texas Intermediate (WTI) oil, which has been responsible for a big lift in the 2018 and 2019 COLA, recently lost a third of its value in a two-month span. As oil prices decline, so will prices at the pump, which provided a double-digit percentage lift in 2018 and 2019. The silver lining here is that energy has a relatively minimal weighting next to other categories within the CPI-W, so it alone can't sink the ship. But it can certainly put a sizable hole in the ship to the point that it takes on water.

Perhaps a bigger worry is what's happening within the housing industry. In California, a market known for its industry leadership, existing single-family home sales tumbled 12.4% in September from the year-ago period. Furthermore, inventory levels reached a 31-month high, with a number of sellers reducing their sale prices from August in an attempt to coerce buyers to make the leap. While this doesn't mean we're on the verge of another housing crisis, it does raise some warning signs that the housing market isn't as robust as once believed. If shelter inflation slows next year -- and shelter bears about a third of the total CPI-W weighting -- it will be felt.

There's also the expectation that economic growth in the U.S. will slow in 2019. This year, lower corporate and personal income tax rates, tied to the passage of the Tax Cuts and Jobs Act, have helped boost quarterly GDP growth to roughly four-year highs. However, that growth rate could be tough to maintain based on tax cuts alone, and without the prospect of further stimulus now that Democrats have regained the House.

Moreover, a Chicago Fed letter penned by Federal Reserve Bank of Chicago members William A. Strauss and Thomas Haasl calls for forecasted GDP growth of 2.2% in 2019. That's down from an estimated 2.8% in 2018 and an actual GDP growth rate of 2.6% in 2017. While Strauss and Haasl's opinions are their own, and not that of the Federal Reserve of Chicago, their model assumes a WTI price of $65.75, and modest growth in housing starts to 1.35 million units. Neither of these figures is looking all that realistic at the moment, which would, in my estimation, lead to a minimal COLA for 2020.

Again, I want to reiterate that a lot can change between now and the months that actually matter. But with the way energy and housing are trending as we head into 2019, things aren't looking great for Social Security's 2020 COLA.

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