What is a Cost of Living Adjustment?

Cost-of-living adjustment is made to Social Security and Supplemental Security Income to cancel out the possible aftermath of inflation. Simply referred to as COLA, this measurement is basically equivalent to the percentage increase in urban wage earners and clerical workers consumer price index (CPI-W) for a particular duration. For clarity, well look at Jane who received $4000 in Social Security benefits during 2012. If the COLA for 2013 becomes 2%, Jane would receive $4080 as Social Security benefits for the year.

Back to:BUSINESS & PERSONAL FINANCE

How Does a Cost-of-Living Adjustment Work?

COLAs are used for effective protection against inflation like in the case of the 1970s inflation, where different contracts utilized this system to protect against further devaluing of currencies. The CPI-W which we stated above is actually decided bu the Bureau of Labor Statistics and it is used in calculating the cost-of-living adjustment by the Social Security Administration (SSA). The measurement for COLA is reached by applying the percentage increase in the CPI-W from the third quarter of one year to that of the succeeding year. In 1975, a COLA provision which was aimed to provide automatic annual COLAs based on the yearly increase in CPI-W went into effect after it was approved by the Congress. Before this enactment came to be, Congress's approval of the select legislations was the only factor that affected the increase in Social Security Benefits. COLA has undergone different transformations till date. In 1975, it was calculated using the increase in the CPI-W of the second quarter of 1974 foo the first quarter of 1975 year. After that, COLA measurement was based on the increase of the CPI-W from the first quarter of a previous year and the first quarter of its succeeding year from 1976 to 1983. It was from 1983 that the standard measurement of COLA came to be what we know today. In the 1970s, inflation levels were unstable and ridiculously high, starting from as low as 5.7% to as high as 11.3%. During 1975, the inflation level rose to 9.1%, and COLA was capped at 8%. In 1980, when the inflation rate was at 13.5%, COLA reached its all time high of 14.3%. However, after inflation reduced in the 1990s, COLA dropped to 2%. Due to the slightly unstable nature of inflation currently, COLA could be seen moving between 2% and 3%. In the 2000s too, the COLA rates where still moving the 2% and 3% zones, and there were no increases for 2010, 2011, and 2016. Currently, 2019 COLA rate is 2.8%.

Effect of COLA on Beneficiaries

COLA depends on two factors namely the CPI-W and the employer-contracted COLA percentage. COLA is mostly dependent on the CPI-W since a lack of increase in the CPI-W will also reflect on the COLA like in the case of 2010, 2011, and 2016. Also, the CPI-W is a major determinant in inflation rates and it is measured by annum. In a situation where COLA is not ratified, Medicare Part B premiums will be stagnant for up to 70% of recipients who have their premiums paid from their Social Security Benefits. However, richer citizens, or those who are not taking part in Social Security via their employer, as well as new Medicare recipients will have to pay their Medicare Part B premium increases.

Types of COLA

The U.S. military sometimes grants a temporary COLA to soldier and other employees to carry out job activities or tasks in states or regions with a higher standard of living than their current residence. Since this COLA is temporary, the completion of the work will terminate it, and thus it wont be applied to future Social Security benefits.

Related Topics

• Inflation
• Core Inflation
• Cost Push Inflation
• Demand Pull Inflation
• Wage Push Inflation
• Inflation Spiral (Wage-Price Spiral)
• Agflation
• Basket of Goods and Services
• Indexing and Index Number
• Base Year
• Consumer Price Index
• Substitution Bias
• Quality / New Goods Bias
• Core Inflation Index
• Producer Price Index
• International Price Index
• Employment Cost Index
• Buying Power Index
• Breakfast Index
• Employment Cost Index
• Producer Price Index
• Capital Goods Price Index
• Farm (Agricultural) Price Index
• Harmonized Index of Consumer Prices
• Repeated Sales Method (Real Estate)
• GDP Deflator
• Deflation
• Pigou Effect
• Hyperinflation (Economics)
• Biflation
• Inflation and Redistribution of Purchasing Power
• Inflation Blurs Price Signals
• Inflation Affects Long-Term Planning
• What are the Benefits of Inflation?
• Indexing and Index Number
• Cost of Living Allowance
• Adjustable Rate Mortgage