What is a cost of living adjustment (COLA)?

The Cost of Living Adjustment (COLA) is a mechanism implemented in the United States in 1975 to counter the effects of inflation on the purchasing power of Social Security and Supplemental Security Income (SSI) beneficiaries. The purpose of COLA is to ensure that retirees' incomes are not eroded by rising inflation, thereby maintaining their standards of living. This adjustment is crucial for individuals on fixed incomes, such as retirees, as it helps to mitigate the impact of increasing costs of goods and services.

In the US, the COLA is determined based on the third-quarter average of the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which is calculated by the U.S. Bureau of Labor Statistics (BLS). The CPI-W measures the price change of a basket of goods and services commonly consumed by urban workers and clerical employees. If there is an increase in the CPI-W, Social Security benefits are adjusted accordingly to reflect the rise in the cost of living. However, if there is no increase or the increase rounds to zero, there is no COLA for the following year.

The COLA adjustment for a specific year is typically announced in October, and it becomes effective in December of that year. Recipients of Social Security benefits can calculate their COLA increase by multiplying their current monthly payment by the COLA rate for the year. For example, if the COLA rate for 2022 is 5.9%, a beneficiary can calculate their increase by multiplying their current monthly payment by 0.059. The resulting amount is then added to their current monthly payment to determine their new payment amount for the following year.

It's important to note that not all individuals in the US receive the COLA increase. Only Social Security recipients, including those receiving old age retirement benefits, disability benefits, survivors' benefits, and Supplemental Security Income, are eligible for the COLA adjustment. Additionally, some employers, such as the US military, may offer temporary COLA adjustments to employees in specific locations with higher living costs.

Overall, the COLA mechanism is designed to help protect the purchasing power of Social Security and SSI beneficiaries against the effects of inflation, thereby ensuring that they can maintain their standard of living in retirement or in the case of disability.