Social Security Not Tying Out to my Entry Even Though COLA Equals Inflation
I entered $40,000 for my Social Security payment. Because my COLA rate is equal to my inflation rate, in today's dollars I expected Social Security next year and the years after to be $40,000. But it's slightly less. Why?
Because the projection is showing a year-end value. By year end, one full year of inflation has occurred, which reduces the purchasing power of this year’s Social Security benefit. But the next COLA increase does not apply until January. So at year end, your Social Security benefit is temporarily worth slightly less in today’s dollars, even when the long-term COLA assumption matches inflation.
Example:
Suppose your Social Security benefit this year is $40,000, and both your assumed inflation rate and COLA rate are 3%.
At the end of this year, you are still receiving $40,000, because Social Security does not increase during the year. The next COLA increase will not happen until January.
But by year end, prices have risen by 3%, so that $40,000 has less purchasing power in today’s dollars:
40,000 / 1.03 = 38,835
So even though your benefit is still $40,000 nominally, it is worth about $38,835 in today’s dollars at year end.
Then in January, the 3% COLA increases your benefit to:
40,000 × 1.03 = 41,200
At that point, the benefit is back to roughly $40,000 in today’s dollars:
41,200 / 1.03 = 40,000
Why this happens: inflation reduces purchasing power throughout the year, but the COLA adjustment is applied only once, at the start of the next year.