Retirement planning

A cost-of-living adjustment (COLA) is what, exactly?

You undoubtedly pay close attention to the cost-of-living adjustment, or COLA, which is published each year in October if you’re one of the approximately 70 million individuals getting Social Security benefits. Your monthly benefit will change as a result of the COLA, which is designed to maintain your purchasing power even when inflation-related price increases take place. The Social Security Administration declared in 2021 that the COLA for payments in 2022 would rise by 5.9 percent, which would be the highest increase since 1982.

The COLA for 2023 benefits will climb by a whopping 8.7 percent, according to a 2022 announcement from the Social Security Administration. This would be the biggest increase since 1981.

Here is the calculation for the COLA and who qualifies for the benefit.

How to calculate the COLA

The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a gauge of inflation established by the Bureau of Labor Statistics, serves as the legal foundation for the cost-of-living adjustment (BLS).

Every three months, the BLS conducts a consumer expenditure survey to obtain data from over 7,000 individuals and families on the items they regularly purchase, ranging from personal care items to vehicle registration fees, in order to calculate the index.

In order to find out the price changes for the roughly 80,000 goods included in the CPI-W, BLS data collectors then make phone calls to retail stores, medical facilities, and service businesses.

There is no COLA for the following year if the CPI-W does not move, which happened in 2015 when it did not. The COLA was only slightly increased in 2016 by 0.3%, and it became effective at the beginning of 2017.

Here is a timeline of the COLA increases during the previous ten years:

YearCOLA increaseYearCOLA increase

The CPI-W and its methodology are occasionally up for discussion. For instance, some detractors claim that because it is based on a basket of goods that reflects the spending of younger, working people, it does not adequately reflect the inflation that older retirees face who might spend more on prescription drugs and healthcare services.

Therefore, a year with a small rise or none at all could be very detrimental to Social Security beneficiaries.

Why it’s crucial to increase the COLA

Although COLA increases may appear insignificant, even a minor change can have a significant impact on the value of your dollar over time. For instance, even though inflation has been very low for the previous ten years, from 1990 to 2020, it averaged about 2.4 percent annually.

How much of a difference can inflation of 2.4 percent make? Assume you receive a $2,000 monthly pension when you retire at the age of 62 today. When you reach 74 years old, you’ll need a monthly benefit of $2,658 to keep your purchasing power given inflation of 2.4%. You would require $3,370 each month to have the same purchasing power as when you first retired after another 10 years. Your money would therefore not be as effective at age 84 without a COLA as it was when you first began collecting benefits.

One strategy to combat inflation is to keep money in a high-yielding certificate of deposit or a savings account. To increase your purchasing power, it’s beneficial to maintain a broad portfolio of investments that can increase in value over time and possibly earn more.

Inflation has been significantly greater in 2021 and 2022 than it was in the 2010s, when it was quite low. There have even been instances when inflation reached double digits, such as in the 1970s when legislation establishing COLAs was passed. The COLA is a vital safety net for those on fixed incomes.

One of the biggest errors that people who are close to retirement make is expecting that Social Security will cover all of their expenses in retirement. Here is the average Social Security benefit amount.

A COLA is given to whom?

The majority of people who gain from a COLA are beneficiaries of Social Security retirement benefits, but they are not the only ones. Individuals receiving disability payments, Supplemental Security Income, a government program for seniors 65 and older, as well as blind and disabled people, also receive COLAs.

Cost-of-living adjustments are also made for retirees in the military and the civil service, and some unions negotiate COLAs in their contracts. The CPI-W is also related to eligibility for government programs like food stamps and free lunches at schools.

To sum up

A cost-of-living adjustment is a crucial tool for Social Security users and others to prevent a sharp drop in their purchasing power over time. It’s crucial that employees don’t be overly careful in their other investments since those saving for retirement need to make sure they have money available when they need it.

Similar Posts

Leave a Reply

Your email address will not be published. Required fields are marked *