Social Security and Cost of Living Adjustments – COLA

Older couple looking at their retirement income after receiving a cost of living adjustment (COLA)..

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A cost of living adjustment (COLA) is one of the most important features of individual Social Security retirement benefits. 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 pension plans 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 the 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% inflation rate, a person's income would need to increase over 80% from age 65 to age 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. 

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 for urban wages (CPI-W) as measured by the Department of Labor's Bureau of Labor Statistics (BLS). 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 to begin in December for the subsequent year.

COLA Annual Calculations

Each year the Social Security Administration (SSA) will review the economy and the possibility of issuing a COLA increase. The amount of the increase will depend on the CPI-W. The CPI 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.

Throughout the years, the COLA increase has varied as has the Social Security taxable maximum. The taxable maximum is the earning amounts that are subject to being assessed Social Security taxes. Since 1980, the annual COLA has been as high as 14.3%—during 1980, a period of high inflation—and as low as 0%—during 2009, 2010, and 2015.

According to the SSA, the increase was 1.7% in 2014, skipped an increase in 2015, crept up 0.3% in 2016, then went to 2% for 2017, before the increase of 2.8% in 2018. The maximum taxable earnings were at $118,500 in 2015 and 2016, rose to $127,200 in 2017, then to $128,400 in 2018, before being set as $132,900 for 2019.

Earnings, COLA, and Your Benefits

The Social Security retirement earnings limits adjust with COLA as well. Individuals who are 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 $17,040 ($1,420 per month) in 2018 before any deductions from your benefits payment are taken. Social Security deducts $1 for every $2 earned in excess of that $17,040 limit prior to full retirement age.

For Social Security beneficiaries celebrating their 66th birthday in 2018, the earnings limit is $45,360. Until the month of your birthday, for every $3 earned during the year, Social Security will deduct $1 from benefit payments. Once you reach full retirement age, the earnings limits no longer apply.