Why Social Security’s Inflation Protection Is Priceless

The 8.7 percent cost-of-living adjustment for Social Security isn’t just a big benefit increase.

It’s priceless.

You can’t buy inflation-protected lifetime income like that on the open market, not from an entity as solid as the United States government.

“People don’t appreciate what a terrific thing Social Security is, in so many ways,” said Charles D. Ellis, an author and investment consultant who has studied Social Security for decades. “The COLA is a reminder: When there is serious inflation, as we have right now, you can count on Social Security taking care of it for you.”

If you are an investor, there are many ways of hedging against inflation, like I bonds, which are issued by the Treasury Department and currently pay 9.62 percent interest.

But safe, monthly lifetime income that automatically keeps up with inflation? You get that with Social Security.

“It’s just what investors need for retirement,” Zvi Bodie, professor emeritus in finance at Boston University, said in an interview. “But, unfortunately, you can’t really get it anywhere else.”

How It Started

While the market value of Social Security’s inflation-adjusted income can’t be easily priced, it can be evaluated in limited ways.

The new COLA is really big — the biggest since 1981, when the adjustment was 11.2 percent. These automatic, yearly inflation increases began in 1975, during a decade of high inflation, when politicians understood that retirees needed help to keep up with rising prices. Before then, it took specific congressional action to raise benefit levels.

The first automatic increase was 8 percent in 1975; the highest was 14.3 percent in 1980. The adjustments didn’t drop below 5 percent until 1983, after the Federal Reserve, led by Paul A. Volcker, threw the economy into two successive recessions.

Until last year’s 5.9 percent COLA, the previous nine annual adjustments were invariably below 3 percent. Social Security COLAs didn’t command big headlines.

A Look at the Current Numbers

But high inflation has come back with a vengeance, and the current COLA is welcome for the roughly 70 million people, including retirees and the disabled, who receive Social Security benefits.

For someone receiving $1,754 a month — the average monthly benefit for someone retiring in December — the COLA means an increase of about $153 a month, or $1,831 a year.

For many people, these increases are absolutely critical.

Consider a few statistics.

Among older women who receive Social Security retiree or survivor benefits, 42 percent get at least half their income from Social Security. Among older men, 37 percent do. If you are living on Social Security, every cent matters after the price of food has risen 11.2 percent this year, as the latest numbers show.

Even for fairly affluent people, the inflation-adjusted payments can be significant.

Imagine that your earnings have put you at the high end of the national income distribution for many years. In addition, you have followed the standard advice to maximize benefits by not claiming Social Security until you reach 70. That will get you the maximum retirement benefit for Social Security, which is $4,194 a month, or $50,328 for this year.

The inflation adjustment amounts to an annual increase of about $4,379, raising your yearly Social Security benefits to $54,707. And the inflation increase will be compounded, as part of your Social Security income, year after year.

I don’t know about you, but the total strikes me as substantial. What’s more, if prices soar next year, there will be another significant inflation adjustment.

Most jobs don’t afford this kind of protection, but Social Security is different. You don’t have to convince anyone that your income — now or in the future — ought to keep up with inflation.

Social Security may seem irrelevant if you are young. You may believe it’s too early to think about retirement, or you may have been told that Social Security won’t be there for you when you are older.

But be aware that these inflation adjustments are likely to affect you.

All else being equal — that is, if your promised benefits aren’t cut because of future funding shortfalls — the inflation adjustments will increase what you receive down the road.

Now, it’s true that unless Congress takes action, the Social Security Trust Funds are projected to run out of money around 2035. If that happened and Congress did absolutely nothing, the tax revenues coming regularly into the Social Security system would still pay about 80 percent of your promised benefits.

But what about the rest of the money?

I asked Mr. Ellis. He is a co-author of the book “Falling Short: The Coming Retirement Crisis and What to Do About It.”

First, he said, Congress is virtually certain to fully protect people already receiving benefits. “No politician wants to tell older people, who vote in large numbers, that their benefits are being cut,” he said.

As for everyone else, it’s important that people understand how valuable these benefits are and make their voices heard, Mr. Ellis said. Social Security has been short on funds before, and the Trust Funds can easily be built up again, much as they were in the 1980s. “I think the more people understand about Social Security,” he said, “the more likely it is that it will be preserved.”

An Invaluable Benefit Without a Market Price

All that said, how much would Social Security be worth if you could buy and sell a lifetime of benefits?

You can’t really do this in financial markets, but let’s look more closely.

In technical terms, Social Security is a form of an annuity — insurance that pays annual income for the rest of your life (and, for retirees, with benefits for your surviving spouse and children until they reach age 18).

Annuities are sold by insurance companies in many shapes and sizes, but they aren’t popular, even though economists often recommend simple, low-cost annuities for safe and stable income.

You can buy annuities that will increase their payouts by, say, 3 percent every year, but none are available now that include full cost-of-living adjustments like Social Security.

There are two reasons for this, said Wade Pfau, a professor of retirement income at the American College of Financial Services. First, inflation was so low for so long that there was little demand for them, and the market withered. Second, as the current inflation surge demonstrates, “no one can accurately predict inflation, and it’s extremely difficult for insurance companies to make long-term projections and price the annuities properly,” he said.

Ariel Stern, the chief operating officer of ImmediateAnnuities.com, which provides estimates of annuity costs, identified the only person who had ever used the service to buy an annuity with a full COLA. That was Jim Oatman, a 73-year-old actuary in Arizona, who purchased one from Principal for himself and his wife in 2018, shortly before Principal, the last company to offer such annuities, stopped selling them.

In a telephone interview, Mr. Oatman said he had paid $200,000 for the annuity. Its monthly payouts started at $602 in early 2019. That was about half of what he said he could have gotten in monthly payments for an annuity without an inflation adjustment.

“It’s expensive, but I’m a numbers guy, and I remember the 1970s and wanted the protection,” Mr. Oatman said. One COLA increased the payments to $635 a month, and another, bigger “bump” will come in November, he said, but added ruefully, “It will take years of inflation for me to catch up to what I would have had without that inflation adjustment.”

Still, “it’s a risk thing,” he said. “If inflation goes very high for several years running, I’m going to feel like the smartest guy around.”

Even when you could buy an annuity like that, the market was tiny. In addition, interest rates were lower a few years ago, and payouts for annuities were lower, too. For these reasons, we can’t really use Mr. Oatman’s annuity to come up with reliable market pricing for Social Security benefits.

In addition, no private company is directly comparable to the U.S. government, which, even with its manifest problems, is backed by the world’s largest economy and most powerful military. In theory, the government should be safer than a mere corporation — if not for Social Security funding’s politics-induced uncertainty, which economists have been measuring for years.

Still, for a ballpark estimate, it seems safe to say that as an annuity on the open market, the average monthly Social Security benefit awarded in December, even without that invaluable COLA, would be worth close to $300,000 and probably much more, based on estimates from ImmediateAnnuites.com.

Even at the low end, that’s more than double the $144,000 that the average household had in 401(k) and individual retirement accounts in 2019, according to the most recent estimates provided by Anqi Chen, a senior research economist of the Center for Retirement Research at Boston College. The inflation adjustment has immeasurable value on top of that.

If you are fairly affluent, consider this.

As an annuity, the maximum Social Security benefit without any COLA would be worth at least $665,000 and as much as $909,000. Adding a COLA of any kind would push its value to $1 million, and much more than that for a full inflation adjustment linked to the Consumer Price Index, like Social Security’s.

If anything, these numbers understate Social Security’s monetary value. They are intended merely to give you an appreciation of benefits that are, really, priceless.

Anything that precious needs to be preserved.

By all means, put away as much money as you can and invest it wisely.

But these estimates suggest that the most important steps most Americans can take to fortify their retirement involve Social Security.

Work as long as you can at a job you enjoy, and delay claiming Social Security until as late as possible — ideally, until you turn 70. That’s just a start.

You must pay Social Security taxes your entire working life. If you want to collect what you are owed when the time comes, make it crystal clear to the political class that you expect every cent of the Social Security benefits you have been promised.