Social Security and Cost of Living Adjustments (COLA)
How cost of living adjustments or COLAs increase your retirement benefits
A cost of living adjustment (COLA) is one of the most important features of the individual Social Security retirement benefit. With a COLA your monthly payment is indexed for inflation -- that means that, should inflation rise, the monthly income rises with it. (Many other defined benefit pensions pay a fixed amount each month, regardless of the inflation rate.) While inflation indexing during a one- or two-year period is not terribly meaningful, the value of this type of inflation protection increases dramatically over the 20 or 30 years a healthy person might live in retirement.
COLA Helps Keep Up With Financial Needs
Under congressional legislation, Social Security benefits have been indexed for inflation since 1973. During the first few years, legislation was required for each adjustment. As of 1975, adjustments for cost of living are made automatically. During periods of positive inflation, Social Security retirement benefits increase to reflect rising costs.
Inflation protection is designed not to increase the standard of living of a Social Security beneficiary but to maintain the purchasing power of income benefits over time. For example, assuming a modest 3 percent inflation rate, a person's income would need to increase over 80 percent from age 65 to age 85 just to maintain a consistent standard of living. If inflation were 4 percent, that income would have to more than double during those 20 years to keep the same purchasing power.
How the COLA Is Determined
A specific formula drives the determination of the COLA. The calculation is based on the third quarter increase in the Consumer Price Index (CPI-W) as measured by the Department of Labor's Bureau of Labor Statistics. If there is an increase in the CPI-W compared to the third quarter in the previous year, a COLA will be made. If there is no increase, there's no COLA.
A new COLA is announced each year, typically during the month of October. Any adjustment will apply to benefits paid beginning in December for the subsequent year.
COLA Annual Calculations
The amount of the COLA increase will depend on the CPI-W. Since 1980, the annual COLA has been as high as 14.3% (1980, a period of high inflation) and as low as 1.3% (1998). The Social Security Administration announced a cost of living adjustment of 0.3 percent beginning in January 2017. The maximum amount of earnings subject to the Social Security tax (taxable maximum) will increase to $127,200. The maximum amount of earnings subject to the Social Security tax remained unchanged in 2016 because there weren't any cost of living adjustments.
The COLA in 2015 was 1.7 percent. However, there was not a cost of living adjustment for 2016. Also in 2015, the maximum amount of earnings subject to the Social Security tax increased to $118,500.
According to the Social Security Administration, "of the estimated 173 million workers who will pay Social Security taxes in 2017, about 12 million will pay more because of the increase in the taxable maximum.".
For more detailed information on the indicator, take a look at the COLA history since 1975.
Earnings and COLA
The Social Security retirement earnings limits adjust with COLA as well. Individuals younger than full retirement age (which varies according to the year in which you were born but is age 66 for those born between 1943 and 1954) who receive Social Security benefits and go back to work can earn up to $16,920 in 2016 before any deductions are taken. Social Security deducts $1 for every $2 earned in excess of that $16,920 limit prior to full retirement age.
For Social Security beneficiaries celebrating their 66th birthday in 2016, the earnings limit is $44,880. Until the month of your birthday, for every $3 earned during the year, Social Security will deduct $1 from benefits. Once you reach full retirement age, the earnings limits no longer apply.