What Are Social Security COLAs and How Are They Calculated?

The question, what are Social Security COLAs (cost of living adjustments) comes up a lot. The equally common problem is, how are they calculated?

In this post, I’ll answer these two questions and give some background on how these two things impact Social Security benefit checks.

To get it from the horse’s mouth, I went to this Social Security website page, Cost-of-Living Adjustment (COLA) Information for 2018. The first part of the page shows the 2018 COLA adjustments. To learn more, here is a 2018 Fact Sheet. They also have fact sheets for the last several years.

A brief history of COLAs

In 1972, President Richard Nixon signed into law the H.R. 1, the Social Security Amendments of 1972. Congress debated for three years before agreeing on the final bill.

The amendment introduced changes to the retirement test. That assured working longer resulted in higher benefits. Another change created a minimum benefit amount for those who worked in lower wage jobs. If you work beyond age 62 receive higher benefits.

Beginning in 1975, automatic annual cost of living allowances became part of the Social Security provisions. Before that, Congress decided if, when, and how much COLAs were. Now, they get calculated based on a consumer price index (more on that later). The Social Security Administration (SSA) assesses this measure in October each year and announces COLAs for the following year.

You can see the history of these increases (or lack thereof) at the bottom of the page referenced earlier (Cost-of-Living Adjustment (COLA) Information for 2018).

With the low inflation of the last few years, increases have been quite low. In fact, there was no increase for 2016. Here are the COLAs for the last five years:

2012 – 3.6%        2013 – 1.7%        2014 – 1.5%        2015 – 1.7%        2016 – 0.0%        2017 – 0.3$         2018 – 2.0%

How SSA calculate COLAs

The SSA determines COLAs based on the Consumer Price Index (CPI-W) increase from the third quarter of each year.Click to Tweet

They announce those changes in October for the following year. Intense debate continues whether the CPI-W is the right measure to use. According to the  Bureau of Labor Statistics‘  (the agency responsible), the CPI-W index is meant to “track retail prices as they affect urban hourly wage earners and clerical workers.”

The CPI-W only covers around 37% of the workforce.

According to the Bureau of Labor Statistics, the CPI-U is “a more general index and seeks to track retail prices as they affect all urban consumers. It encompasses about 87 percent of the United States' population.” One of the major criticisms of the CPI-W is that it dramatically underestimates healthcare costs.

For senior citizens, that represents a much more significant percentage of expenses than the working population.

 Follow this link to the Social Security Administration page on cost of living adjustments.

Other changes announced each year

In addition to the announcement of the COLAs, the October announcement includes several other changes.Click to Tweet

One of those is the income on which we pay Social Security taxes. Like with COLAs, this may or may not change each year.

However, it's always included in the list, even when there is no change. Other things announced are FICA and Medicare tax rates, disability thresholds, and maximum benefit amounts.

If you are working while receiving Social Security benefits, the SSA applies an earnings test to see if your SS income become taxable.

There is a limit to the income you can earn before they get taxed. Those income thresholds are a part of the annual October announcement.

Final thoughts

The Social Security rulebook contains over 2,700 rules!

It’s virtually impossible for anyone to know them all. The SSA website is an excellent place to get your questions answered about benefits.

It’s always best to educate yourself before going to your local SSA office or calling them on the phone.

Recent rule changes in November 2015 brought more confusion and complexity to the rulebook. I’ve heard horror stories from clients and others who got the wrong information from SSA personnel.

They do the best they can and, in general, are very good. However, it’s impossible for anyone to keep track of the 2700 rules.

Trying to navigate this journey on your own may prove to be a nightmare.

There are good software options available to help you calculate the optimal claiming strategy based on the current rules.

Good financial advisors should be well versed in this area to guide you through the maze. Don't be afraid to ask for help.

Now it's your turn. Let me know if this article was helpful. Let me know where you are in your retirement journey? Are you retired? Have you claimedSociall Security?

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