Are Social Security Benefits Inflation-Adjusted?

There is a cost-of-living adjustment (COLA) based on an index

Reviewed by Charlene RhinehartFact checked by Vikki Velasquez

The short answer is yes: Social Security benefits are adjusted upward for the effects of inflation. This Social Security cost-of-living increase is officially known as the cost-of-living adjustment (COLA). Each year, the Social Security Administration (SSA) decides whether the following year’s benefit will include a COLA and, if so, how large it should be. Contribution levels into the program are also linked to inflation.

The longer answer is more complicated: Some expenses, particularly those facing retired people, are not always reflected in inflation data. If those costs increase faster than the COLA, senior citizens may suffer a net loss of buying power.

Social Security benefits were not always adjusted for inflation—that started in the 1970s. Let’s take a look at what prompted the SSA to implement the COLA and how it is determined.

Key Takeaways

• Social Security benefits, as well as contributions, are linked to changes in inflation over time.
• The Social Security Administration enacted the COLA in the 1970s in the wake of double-digit inflation.
• The COLA is based on increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).

Social Security COLA History

For the Social Security program’s initial four decades, benefit amounts did not increase automatically based on higher living costs. They only changed sporadically, when Congress approved a hike through legislation.

However, in the 1970s, the cost of living started skyrocketing for many Americans. The removal of the dollar from the gold standard, rising oil prices, supply shocks, and other factors had triggered unprecedented inflation that would plague the U.S. throughout the decade. Though workers received some relief from rising prices because their wages also climbed, people on fixed incomes struggled badly, particularly senior citizens. Having Social Security adjusted for or indexed to inflation was necessary to ensure that beneficiaries with no other sources of income could still pay their bills.

All this prompted Congress to modify the Social Security program so that inflation would trigger increases in benefit amounts. Congress enacted the Social Security COLA in 1972, but it didn’t take effect until 1975.

Note

The original amendments to Social Security required inflation to be at 3% during the specified base period before a COLA could be triggered. As part of the Omnibus Budget Reconciliation Act of 1986, lawmakers eliminated the 3% trigger, requiring instead that, for a COLA to be payable, inflation (or wage growth in certain cases) just has to be greater than 0% during the specified base period.

How the COLA Is Determined

Social Security recipients do not automatically receive a COLA increase every year.

The COLA is based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), as calculated by the Bureau of Labor Statistics (BLS), part of the U.S. Department of Labor. The CPI-W measures what workers with modest incomes pay, on average, for retail goods.

When the CPI-W increases by more than 0.1% between the third quarter of the previous year and the third quarter of the current year, the Social Security Administration adds a COLA to Social Security benefits. Benefits increase by the same amount as the index. During years when the CPI-W increase is nominal or negative, Social Security recipients receive no COLA.

8.7%

The COLA increase for 2023 benefits, compared with a 5.9% adjustment for 2022 and a 1.3% increase in 2021. The significant increase — the highest in 41 years — reflects rising prices due to the COVID-19 pandemic.

The Social Security Administration typically announces the COLA in October for changes that will take effect the following year.

The 8.7% increase for 2023 was the highest in over 40 years. Other significant recent increases occurred in 2008 (5.8% for 2009) and 1990 (5.4% for 1991). There was no increase in 2015. Notably, the COLA reached a record high of 14.3% in 1980, when the inflation rate was 13.5%.

COLA vs. Actual Cost Increases

Although the Social Security Administration may provide a COLA, this increase is based on the average prices of a basket of consumer goods that may not reflect the actual expenses of social security recipients.

A study by the Center for Retirement Research found that retirees lose buying power in two ways, even with a COLA. First, Medicare Part B premiums tend to rise faster than inflation, resulting in a net loss of buying power. Second, the threshold for taxing social security benefits is not adjusted for inflation, meaning that a high COLA may increase one’s tax burden.

A study by the Senior Citizen’s League, which advocates for retired people, claims that “COLAs have increased Social Security benefits by a total of 64 percent, yet typical senior expenses through March 2022 grew by more than double that rate — 130 percent.”

Read the original article on Investopedia.