Last week, the Social Security Administration (SSA) announced the COLA (cost of living adjustment) for current recipients will be 1.6% in 2020. The increase will be welcome news, but have you ever wondered how the COLA is calculated?
Since 1975, Social Security’s COLA is tied to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). What might surprise you is how few months of the index are used in the calculation. Only readings from the third quarter (July through Sept) are considered.
To determine the next year’s COLA, the SSA compares the average reading from the current year’s third quarter CPI-W with the average reading from the third quarter of the previous year. If the current year’s reading is higher than the previous year’s, it implies inflation happened which increases the COLA for SS recipients.
The other interesting aspect of the COLA calculation relates to the index itself. The CPI-W tracks the increase in general price level for urban wage earners and clerical workers not retirees. It means the index has an underweight to expenses like healthcare and housing which are important to seniors and an overweight to the cost of education, apparel and transportation which aren’t impacting seniors’ budgets nearly as much.
What does a 1.6% increase mean to current beneficiaries? Since the average retired worker and disabled person receive approximately $1473 and $1236 per month, the 2020 COLA increases their checks $24 and $20, respectively. This increase is most helpful in offsetting any potential increase in Medicare premiums.