What Is a Cost-of-Living Adjustment (COLA)?
A cost-of-living adjustment (COLA) is an increase made to Social Security and Supplemental Security Income to counteract the effects of inflation. Cost-of-living adjustments are typically equal to the percentage increase in the consumer price index for urban wage earners and clerical workers (CPI-W) for a specific period. So if someone received $10,000 in Social Security benefits last year and the COLA for this year is 4.1%, his or her benefits for this year would be $10,410.
- A cost-of-living adjustment (COLA) is an increase in Social Security benefits to counteract inflation.
- Inflation is measured using the consumer price index for urban wage earners and clerical workers (CPI-W).
- Automatic yearly COLAs began in 1975.
- The COLA for 2020 is 1.6%.
Understanding Cost-of-Living Adjustment (COLA)
Because inflation was high during the 1970s, compensation-related contracts, real estate contracts, and government benefits used COLAs to protect against inflation. The Bureau of Labor Statistics (BLS) determines the CPI-W, which is used by the Social Security Administration (SSA) to compute COLAs. The COLA formula is determined by applying the percentage increase in the CPI-W from the third quarter of one year to the third quarter of the following year. This information is updated regularly on the SSA website.
Congress ratified a COLA provision to offer automatic yearly COLAs based on the annual increase in the CPI-W that went into effect in 1975. Prior to 1975, Social Security benefits were increased when Congress approved special legislation. In 1975, COLAs were based on the increase in the CPI-W from the second quarter of 1974 to the first quarter of 1975. From 1976 to 1983, COLAs were based on the increases in the CPI-W from the first quarter of the previous year to the first quarter of the current year. Since 1983, COLAs have been dependent on the CPI-W from the third quarter of the previous year to the third quarter of the current year.
COLAs depend on the CPI-W from the third quarter of the previous year to the third quarter of the current year.
Inflation levels ranged from 5.7% to 11.3% in the 1970s. In 1975, the COLA increase was 8%, and the inflation rate was 9.1%. In 1980, COLA reached the highest level in history at 14.3%, while the inflation rate was 13.5%. During the 1990s, drastically lower inflation rates prompted small COLA increases averaging 2% to 3% per year. That continued into the early 2000s when even lower inflation rates resulted in no COLA increases at all in 2010, 2011, and 2016. The COLA for 2019 was 2.8% and the COLA for 2020 is 1.6%.
COLA is reliant on two components: The CPI-W and the employer-contracted COLA percentage. CPI determines the rate of inflation and is compared yearly. When consumer prices drop—or if inflation has not been high enough to substantiate a COLA increase—recipients do not receive a COLA. If there is no CPI-W increase, there is no COLA increase.
When a COLA increase is not approved, Medicare Part B premiums remain the same for approximately 70% of beneficiaries who get the premiums deducted from their Social Security checks. However, the remaining recipients—such as those with higher incomes, those who did not participate in Social Security through their employer, and new beneficiaries—must pay the Medicare Part B premium increases. The standard monthly Medicare Part B premium set for 2020 is $144.60. That's a $9.10 increase from 2019 when it was $135.50.
Other Types of COLAs
Some employers such as the U.S. military occasionally give a temporary COLA to employees who are required to perform work assignments in cities with a higher cost of living than their home city. This COLA expires when the work assignment is finished.