Social Security's 3.6% COLA Bump Could Push the Program Toward a Funding Crisis

The good news for Social Security recipients is that they appear to be on pace for a respectable 3.6% increase in their benefits early next year. The bad news is that this above-average rise in the program's payments raises the likelihood of a sizable reduction in everyone's future payments by 2032.

Here's what you need to know.

One has nothing to do with the other

For decades, American workers paid more total money in wage taxes into Social Security than it paid out in benefits. The surplus flowed into the Social Security Trust Fund -- a reserve intended to cover the shortfall that would occur after benefit payouts exceeded the program's revenues. That shift happened some time ago. And according to Social Security's Board of Trustees, by the end of 2032, the Trust Fund will be totally depleted.

Even after that happens, the FICA taxes still being paid by all workers should be enough to continue funding retirees' benefits at 78% percent of prior levels, based on current projections. But at that point, assuming that Congress doesn't make changes in the meantime to shore up the program, Social Security's monthly payments will have to be reduced by 22% of whatever's being dished out to its retired beneficiaries at that time.

Nevertheless, retirees who receive benefits between now and then will still see their payments rise in step with inflation each year in the meantime, including the cost-of-living adjustment (COLA) scheduled for January. That one should be a good one, too. Following the latest inflation report from the Bureau of Labor Statistics (BLS), which indicated that the United States' overall annualized consumer inflation rate stood at 3.4% in July, the nonpartisan Senior Citizens League expects 2027's COLA to be a 3.6% increase. Because the government calculates the size of each year's COLA based on the inflation rates from July, August, and September of the prior year, we won't get an official figure for 2027's COLA until October, after September's inflation report is published.

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This begs an important question: If the Social Security Trust Fund is under strain, why add to that strain by boosting payments and depleting it faster? After all, while many retirees will certainly appreciate the inflation-adjusted increase in their payments, most would likely forego some or all of a COLA if it meant extending the program's longevity.

The answer is that Social Security's annual payment increases are required by law, regardless of how well the program's Trust Fund is funded. Conversely, the amount of the program's yearly funding is purely a function of the number of people paying FICA taxes and the amount of taxable income they're earning (plus some interest from the Treasury bonds it holds), regardless of the program's actual need. When the number of taxpaying workers and the amount of money they're making are relatively low compared to the number of retirees -- as is the case now -- the fund shrinks.

Approaching the tipping point

Although the government has been able to proverbially kick this can down the road several times now, the inherently flawed design of Social Security's funding mechanism and the program's growing disbursements are finally coming to an inescapable head. Politicians in Washington must deal with it soon, before the matter moves past the point of no return. Whether that's going to happen remains to be seen.

Just know this: As long as Social Security's annual cost-of-living adjustments are bigger than the historical average of the nation's consumer inflation rate, the program's Trust Fund will be drained at a faster than anticipated rate. Something's got to give one way or another, and sooner rather than later.

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