Inflation Has Negative Effect On Social Security, Pension Funds

(KNSI) – The United States Social Security Administration announced Thursday a historic cost of living adjustment for next year.

The COLA figure is supposed to move parallel with inflation to ensure that seniors and the disabled don’t lose purchasing power over time. The 8.7% change was expected, but it is still significantly higher than what the base case assumption was when determining the program’s financial footing just two years ago.

Saint Cloud State University Economics Professor King Banaian says previous estimates for insolvency will likely be too rosy.

“In short, the Social Security Fund will become insolvent sooner rather than the numbers already projected.”

The agency’s last estimate was for financial distress to occur in 2033. If Congress does not make changes to avoid it, benefits are automatically slashed to 77 cents for every dollar previously promised when insolvency is declared.

Another factor working against the program is its reliance on payroll taxes. The labor force participation rate dropped to historic lows in 2020 as economic shutdowns closed entire industries after the outbreak of COVID-19. While the job market has recovered, the percentage of able-bodied Americans employed remains below pre-pandemic levels. The trust fund is looking at a situation where fewer people are paying into a system that requires more money than what was previously estimated.

Banaian says other countries are in greater jams. He says the United Kingdom and elsewhere are looking at a crisis.

“A lot of pension funds saw those very low interest rates and decided to make investments based on them continuing, and may now be caught in a position like the UK pension funds are, where the rapid rise in interest rates is causing them to lose money on alternative investments they used to juice their returns.”

Most defined benefit pension funds assume returns between five and eight percent when calculating how much funding is required to meet future obligations. With bonds anchored by central banks at zero percent or even negative yields, for years, it was almost impossible to hit those targets without taking on substantial risk.

Banaian says he thinks American retirement plans will fare better.

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