What is a 'Cost-of-Living Adjustment - COLA'?

A cost-of-living adjustment is made to social security and supplemental security income to counteract the effects of inflation. Cost-of-living adjustments (COLAs) 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.

For example, if Kevin received $10,000 last year in social security benefits and the COLA for this year is 4.1%, his benefits for this year would be $10,410.

BREAKING DOWN 'Cost-of-Living Adjustment - COLA'

During the 1970s, inflation was high. As a result, compensation-related contracts, real estate contracts and government benefits used COLAs to protect against inflation.

The Bureau of Labor Statistics (BLS) determines 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.

Congress ratified a COLA provision to offer automatic yearly COLAs based on the annual increase in 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 are dependent 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.

The Effects of COLA on Recipients

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 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.

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 there home city. The COLA expires when the work assignment is finished.

RELATED TERMS
  1. Consumer Price Index - CPI

    The Consumer Price Index examines the weighted average of prices ...
  2. Indexation

    Indexation is a method of linking the price or value of an asset ...
  3. Social Security Administration ...

    The Social Security Administration (SSA) is a U.S. agency that ...
  4. Actuarial Balance

    Actuarial balance is the difference between future Social Security ...
  5. Inflation Protected

    Inflation protected refers to types of investments that provide ...
  6. Participation Mortgage

    A participation mortgage allows the lender to share in part of ...
Related Articles
  1. Retirement

    Social Security Announces Meager 0.3% COLA

    The Social Security cost-of-living adjustment is just 0.3% in 2017; advocates say senior inflation's much more. Result: Medicare costs will soar for some.
  2. Retirement

    Social Security Changes to Expect in 2018

    Here are the changes to the Social Security program set to take effect on Jan. 1, 2018.
  3. Retirement

    Top 6 Myths About Social Security Benefits

    Misinformation on retirement benefits is common. We'll set the record straight.
  4. Retirement

    Can Your Pension’s Cost-of-Living Clause Be Frozen?

    Recent events in New Jersey prove that relying on a pension alone to fund your retirement is risky. Make sure you have multiple retirement income sources.
  5. Personal Finance

    The Retirement Divide: CEOs vs. the Rest of Us

    CEOs do great, but a new report has troubling news for the average American retiree.
  6. Retirement

    403(b) Plans: More Than Supplemental Retirement

    Whether you choose a 403(b) or fixed annuity, you may need supplemental retirement income.
  7. Retirement

    The Facts About Social Security's Solvency

    Will Social Security really go broke in the not-so-distant future? Here are the facts.
  8. Tech

    Google Searches for 'Bitcoin' Down 75%

    Bitcoin remains the most popular digital currency, but investors are searching for it less and less.
  9. Small Business

    5 Products That Failed And Why

    Not every new strategy or product launch goes well; even those with big-name companies behind them can still fail.
  10. Retirement

    5 Tips to Increase Your Social Security Check

    These planning tips could increase your Social Security income benefits, which can significantly enhance your financial security.
RELATED FAQS
  1. Are Social Security benefits adjusted for inflation?

    Learn how the Social Security Administration adjusts benefit amounts for inflation, and how 1970s inflation triggered this ... Read Answer >>
  2. What is market cannibalization?

    Market cannibalism is defined as the negative impact a company's new product has on the sales performance of existing products. ... Read Answer >>
Hot Definitions
  1. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  2. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
  5. Depreciation

    Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account ...
  6. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained in a company’s financial statements.
Trading Center