What is Cost of Living Adjustment?

An increase in income that maintains pace with the cost of living is known as the cost of living adjustment (COLA). It frequently pertains to pay, benefits, and salary. These cover retiree benefits, executive contracts, and union agreements.

How Does the Cost of Living Adjustment Work?

Depending on who is paying the benefits or salary, cost of living adjustment computations may be handled differently. Given how many people receive Social Security benefits—approximately 65 million as of June 2021, according to the Social Security Administration—the Social Security COLA is arguably the most extensively discussed regular adjustment.

Social Security Cost of Living Adjustments

The Social Security Act includes the criteria and calculation method for the Social Security and Supplemental Security Income (SSI) benefit COLA. The potential changes in monthly benefits have been based on inflation rates since 1975.

The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) for the previous and current years is used as the basis for Social Security COLAs today. Benefits rise in line with the CPI-W increase, if there is one, and the amount is disclosed close to the end of the year. Beginning in January of the next year, the increase becomes effective.

Every year since 1975, except in 2009, 2010, and 2015, the Social Security COLA has resulted in benefits rising. The COLA change in 2021 was 5.9%. Therefore, in January 2022, the average Social Security income for retired workers will be $1,658, an increase of $93 from the previous monthly payout.

Alternative Cost-of-Living Adjustments

Different calculations and timetables may be used to determine the COLA for other benefits, pensions, and wages. For instance, many companies and agencies choose to use the CPI-U, or Consumer Price Index, when calculating prospective COLA amounts rather than the CPI-W. Others may choose to employ a local CPI rather than the national CPI.

Your specific COLA may also be influenced by the agreement you have with your employer. In some circumstances, even if you began receiving benefits before that age, you might not receive a COLA until you reach that milestone.

No matter what happens to the CPI, there may be a minimum and maximum COLA amount. An example would be a pension that, even if inflation is lower, would guarantee a COLA of at least 1% or 2% a year. The COLA, however, may only represent a portion of the CPI rise up to a particular point when inflation is higher than that threshold.

Review your contract or get in touch with your company, HR department, or union representative if you're curious to see how a COLA can affect your pay or benefits.