Social Security and Cost-of-Living Adjustments (COLA)
Learn how inflation indexing can impact your retirement income
A cost of living adjustment (COLA) represents an annual percentage increase in consumer prices that is reflected in your Social Security benefits.
With a COLA, your monthly Social Security payment is indexed for inflation, which means that when inflation rises, your monthly income in retirement will rise with it.
This important feature sets Social Security benefits apart from defined benefit plans like pensions that 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.
Understanding the history, benefits, and calculations of the Social Security COLA can help you stretch your retirement nest egg further.
Social Security COLA History
As a result of Congressional legislation enacted as part of the 1972 Social Security Amendments, Social Security benefits have been indexed for inflation since 1973.
Initially, legislation was required for each adjustment, making it difficult to keep benefits on pace with the high inflation at the time. Starting in 1975, automatic COLAs occurred when the CPI-W increased by at least 3% to more efficiently increase Social Security payments with rises in price. However, lower inflation in the mid-1980s created the possibility of no annual COLA under the 3% trigger, so Congress eliminated it in 1986.
During periods of positive inflation, Social Security benefits still increase to reflect rising costs. But Social Security COLAs are now made based on third-quarter increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) as measured by the Department of Labor's Bureau of Labor Statistics (BLS).
Although the average annual inflation rate from 1913 to 2020 is around 3%, the Federal Reserve targets a 2% inflation rate as it carries out monetary policy.
COLAs Preserve Buying Power
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, particularly during inflationary periods.
For example, assuming a 2% inflation rate, a person's income would have to increase by around 50% from age 65 to 85 just to maintain a consistent standard of living. If inflation were 4%, that income would have to more than double during those 20 years to keep the same purchasing power. The Social Security COLA ensures that your purchasing power isn't eroded over time, which allows you to buy a similar amount of goods and services as you did in prior years.
Social Security COLA Calculation
The amount of the increase depends on the CPI-W, which measures the change in the price of a basket of consumer goods over a period. CPI-W is a version of that data and measures how a segment of workers—urban clerical and wage-paying jobs—are affected by the changes in the CPI.
A specific formula drives the determination of the COLA. A COLA occurs if the average CPI-W from the third quarter of the prior year to the same quarter of the current year increases by at least 0.1%. If the CPI-W decreases or increases by less than 0.05% (which rounds to zero), there is no COLA, and hence, no change in Social Security benefits.
A new COLA is announced each year, typically during the month of October. Any adjustment will apply to benefits beginning in December of the next year.
COLAs Over Time
The SSA annually reviews the economy and the possibility of issuing a COLA increase based on the change in the CPI-W.
Throughout history, the Social Security COLA increase has varied, as has the Social Security taxable maximum, which is the earning amount that is subject to Social Security taxes. Since 1980, the annual COLA has been as high as 14.3%—in 1980, a time of high inflation—and as low as 0%—in 2010, 2011, and 2016.
According to the SSA, the COLA was 1.7% in 2015, was skipped in 2016, crept up 0.3% in 2017, then went to 2% for 2018 before it increased to 2.8% in 2019 and 1.6% in 2020. The maximum taxable earnings were $118,500 in 2015 and 2016, rose to $127,200 in 2017, then to $128,400 in 2018. The limit was set as $132,900 for 2019 and $137,700 for 2020.
Taxable earnings include wages and net profits from self-employment.
COLA Impact on Income Limits and Benefits
Social Security retirement earnings caps also adjust with COLAs. Individuals who are younger than full retirement age—which varies according to when 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 $18,240 ($1,520 per month) in 2020 before any deductions are taken from your monthly benefit payment. Social Security deducts $1 for every $2 earned in excess of $18,240 prior to full retirement age.
For Social Security beneficiaries who reach their full retirement age in 2020, the earnings limit is $48,600. Until the month of your birthday, Social Security will deduct $1 from your benefit payments for every $3 you earn during the year. Starting in the month you reach full retirement age, the earnings limits no longer apply.
U.S. Bureau of Labor Statistics. "Consumer Price Index." Accessed March 31, 2020.
Social Security Administration. "1972 Social Security Amendments." Accessed March 31, 2020.
Social Security Administration. "Cost-Of-Living Adjustments," Page 1. Accessed March 31, 2020.
Board of Governors of the Federal Reserve System. "Monetary Policy Report Submitted to the Congress on February 7, 2020, Pursuant to Section 2b of the Federal Reserve Act." Accessed March 31, 2020.
Federal Reserve Bank of Minneapolis. "Consumer Price Index, 1913-." Accessed March 31, 2020.
U.S. Bureau of Labor Statistics. "CPI Inflation Calculator." Accessed March 31, 2020.
U.S. Bureau of Labor Statistics. "Why Does BLS Provide Both the CPI-W and CPI-U?" Accessed March 31, 2020.
Social Security Administration. "Cost-Of-Living Adjustment (COLA)." Accessed March 31, 2020.
Social Security Administration. "Latest Cost-Of-Living Adjustment." Accessed March 31, 2020.
U.S. Bureau of Labor Statistics. "Maximum Taxable Earnings." Accessed March 31, 2020.
U.S. Bureau of Labor Statistics. "Cost-of-Living Adjustment (COLA) Information for 2020." Accessed March 31, 2020.
Social Security Administration. "Getting Benefits While Working." Accessed March 31, 2020.