What Is A Cost-Of-Living Adjustment (COLA)?

Have you ever heard of the Cost of Living Adjustment, or more commonly referred to as COLA? If you’ve ever gotten Social Security benefits or any benefits from the government, you might have run into COLA.

While COLA isn’t one of the most important parts to understand about the Social Security Administration and Social Security system, it’s a good thing to get familiar with.

COLA doesn’t usually have a huge impact on your benefits between years, but it could make a difference over time.

In this article, we’re going to look at what COLA is, how you can calculate it, and who it affects. Regardless of your job, industry, or employment status, keeping the current year’s Cost of Living Adjustment in mind is a good idea.

What Is COLA?

Almost every year, the Social Security benefit increases as the cost of living increases. The Social Security Administration judges how much the cost of living increases between years and adjusts the benefits accordingly so that the money you receive gives you better purchasing power.

These numbers aren’t random but expertly calculated values, thanks to the Consumer Price Index. The CPI is a number that can show inflation or deflation numerically, and it’s commonly used in economic and governmental fields. It’s calculated by taking a set basket of goods and services, then calculating the average price change between all of the items.

By using the CPI to calculate COLA, the benefit adjustment you receive is in line with the current market. CPI is usually used to make determinations about the cost of living, so it’s an appropriate measurement to use when calculating COLA.

COLA can be applied to a wide range of things, but it’s usually used by the government and not private businesses. The Cost of Living Adjustments can apply to things like wages, salaries, benefits, union agreements, executive contracts, and retiree benefits. Since COLA can affect so many things, it’s crucial to have an understanding of what it is and the COLA for the year.

It can be difficult to understand COLA in the abstract, so let’s look at an example of how COLA impacts your benefits.

For example, Jane earned $1,000 in Social Security benefits last year and the current year’s COLA is 3.2%. Then, Jane would get $1,032 in benefits this year, or 3.2% more than she received last year. These adjustments typically aren’t this high, but it’s a good way to understand how COLA works.

Last year, in 2020, the government decided the COLA would be 1.6%. This was meant to address changes in the economy due to COVID-19 as well as other factors. Now that 2021 is here, the COLA for the year is 1.3%, only slightly lower than it was last year. That means that if you’re receiving government benefits in 2021, you can expect your benefits to increase by 1.3%.

How Is COLA Calculated?

COLA is calculated based on the Consumer Price Index as we outlined above. It’s important to remember that COLA only goes up if the CPI goes up. Since both are meant to remedy the impacts of inflation and the rising cost of living, COLA rarely goes down.

Even if the CPI goes down during a year, COLA won’t rise since those are typically years of deflation. This is rare, but it is possible.

Sometimes even if the CPI increases for a year, there won’t be any COLA changes. If the CPI increase is so slight that it doesn’t merit an increase in COLA, then the COLA rate will stay the same as the previous year.

Since there are so many moving parts to COLA, it’s important to stay informed and have a good idea of the CPI and COLA rates in a given year. It’s especially important to know if you’re receiving any of the benefits that COLA impacts.

Also, it’s important to keep in mind that COLA rates only affect the benefits that you currently receive from the government. They do not compound overtime or change over time; they only impact the current year’s benefits.

For example, if you’re still working and contribute part of your paycheck to Social Security, you won’t see the year’s COLA effects.

If, however, you’re retired and receiving money from the Social Security Administration, you will get that adjustment as we showed above. You’ll see your payout increase according to the year’s COLA if you’re currently receiving benefits from the government.

How Does COLA Affect People?

Since COLA can touch so many different benefits, there are many ways that COLA can affect you. To really understand how COLA affects you, think about what benefits you’re currently receiving from the government.

Since COLA really only applies to the current year and the benefits that you’re receiving, you need to think about how the rate changes will affect you this year.

If the COLA for the year increased and you’re receiving benefits from the government, you can expect an increase in your benefits. If you’re not currently getting government benefits, COLA doesn’t have a big impact on you.

Because COLA fluctuates from year to year, it’s important to keep an eye on any changes if you are receiving benefits. While COLA doesn’t change most years drastically, it’s good to keep informed and make sure you’re getting what you’re owed.

Since the adjustment rate keeps up with the current state of the economy, it can help you make sure that you’re getting enough money to keep you going, especially if you’re on Social Security.

Retirees who get Social Security payments live off a fixed income for the most part, so if you fall into this category, you want to make sure you’re receiving enough to live off of. Retirement payments don’t usually change, so with COLA rates changing, you can get an amount that better reflects the state of the economy and get compensated for any potential inflation.

COLA can also affect people who are temporarily given benefit adjustments. If, for example, you’re in the military and you’re relocated to another city, you might get a benefit adjustment. This is only the case for a few people, but if your cost of living is much higher in your new city than it was in your old city, the government might give you COLA.

If this is the case for you, the COLA will only last as long as you’re in that new city for your military job. Once you return to your old city or you aren’t working with the military, you won’t get the COLA anymore.

While COLA mainly affects people who are receiving government benefits, it can also affect people who work for the government. Since government jobs usually pay less than similar roles in private businesses, COLA is added to give government work extra appeal.

Jobs in the private sector typically already cover the cost of living expenses, but government jobs rely on COLA a little more to make sure that salaries are fair and keep up with any economic conditions.

Depending on what government job you hold, COLA might affect your yearly wages. It’s important to check if you’re working for the government so you can manage your finances accordingly.

Sometimes, companies can create their own COLA rates for different reasons. If this is the case, a private business’ COLA is probably different and unrelated to the government’s COLA rate for the year.

This isn’t always the case, but companies typically establish their own ways of calculating and enacting their COLA rates.

Final Thoughts

Businesses can implement COLA rates for many reasons, but sometimes they’re meant to cover costs of relocation or changes in the economy. Usually, instead of creating a COLA, companies might just give pay raises.

If your company does institute a COLA, get as much information about it as you can. Sometimes it only applies to certain employees in certain roles or applies to employees depending on their salaries.

Whether you’re eligible for COLA from the government or your employer, you should make sure you know all of the facts.

Author

Amanda Covaleski

Amanda is a writer with experience in various industries, including travel, real estate, and career advice. After taking on internships and entry-level jobs, she is familiar with the job search process and landing that crucial first job. Included in her experience is work at an employer/intern matching startup where she marketed an intern database to employers and supported college interns looking for work experience.