Demystifying the COLA

The amount of the annual cost of living adjustment, or COLA, applied to Social Security benefits is probably the most-awaited announcement that the Social Security Administration has the pleasure to make each year.While the COLA has a considerable impact on millions of ¬†SS beneficiaries across the country, the mechanics of the (mostly) regular raise are little understood. I’ve heard some suggest that the COLAs are set each year by Congress, and this was indeed the case until 1975. However, starting in 1975, COLAs have been automatic and based solely on a consumer price index.

Today, SS COLAs are based on the CPI-W. The CPI-W is a price index published by the Bureau of Labor Statistics (BLS, a government agency separate from the SSA) and is intended to represent the prices faced by “urban wage earners and clerical workers.” The BLS tabulates the CPI-W by directly collecting price data from around the country on items in specified “market baskets.” The BLS uses consumer survey data to determine the contents of the market basket, but it’s meant to mirror expenditures felt by “urban wage earners and clerical workers.” It’s worth pointing out that the CPI-W does¬†include food and energy expenditures. Some price indices exclude these items due to their volatility, but the CPI-W, and therefore SS COLAs, do respond to fluctuations in food and energy prices.

The SS COLA is based on the average CPI-W in the third calendar quarter. So, each year in October, the CPI-W from July, August, and September are averaged and compared to the same measure from the year of the most recent COLA. Normally this the 3rd quarter average is compared to that of the previous year, but if there was no COLA in the previous year, then the comparison is made to the most recent year in which there was a COLA. If the 3rd quarter average in the present year has increased by at least 0.1% relative to the 3rd quarter average in the year of the last COLA, then, in December, SS benefits increase by a percentage equal to the difference in the two COLAs. If the 3rd quarter average increases by less than 0.1% or decreases, SS benefits stay the same. SS benefits never fall due to a decline in the CPI-W, there are no negative COLAs.


CPI-W and SS COLA: 2006-2011


Average 3rd quarter CPI-W and SS COLAs in recent years are shown in the chart above. During the recent recession, CPI-W actually fell, but SS benefits remained the same between December 2008 and December 2011. Since there were no COLAs in 2009 or 2010, the 3rd quarter average CPI-W in 2011 was compared to that of 2008, and an increase of 3.6% led to a COLA last December. Looking ahead to the next COLA measurement, the CPI-W has stayed almost exactly the same since the 3rd quarter of 2011. Although there has been no increase in CPI-W as of yet, the possibility of another COLA in December of 2012 is far from being ruled out. Stay tuned to this blog for updates on CPI-W and a potential COLA in 2012.

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