Social Security provides monthly benefits to retired workers and their spouses, as well as to disabled workers and their dependents. Many Americans rely on these payments as their primary source of income after retirement. Social Security benefits are adjusted each year to account for inflation through Cost-of-Living Adjustments (COLAs). These COLA increases are meant to protect the purchasing power of Social Security benefits against the rising prices of goods and services. However, there is some confusion around whether COLA payments are separate from regular Social Security benefits. This article will examine if COLA payments are distinct from base Social Security benefits or simply adjustments to existing payments.
How Social Security benefits are calculated
Social Security benefits are based on a worker’s earnings history and the age at which they first claim benefits. The Social Security Administration calculates a worker’s Primary Insurance Amount (PIA), which is the monthly benefit due at full retirement age. This full retirement age is currently 66 for those born 1943-1954, but is gradually increasing to 67 for those born in 1960 or later. Early retirement can be claimed as early as age 62, but at a reduced benefit amount. Delayed retirement credits are applied for those who claim after full retirement age, up to age 70.
The PIA formula takes a worker’s 35 highest earnings years, adjusted for inflation. This adjusted total is divided by 420 months to determine the Average Indexed Monthly Earnings (AIME). Applying a progressive formula to the AIME produces the PIA, which is the worker’s full monthly benefit if claimed at full retirement age. The PIA formula replaces a higher percentage of earnings for low earners compared to high earners. Cost-of-living adjustments are applied to the PIA, not to a worker’s lifetime earnings.
What are COLA increases?
Cost-of-Living Adjustments (COLAs) are annual increases applied to Social Security benefits to account for inflation. They are calculated based on changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). When prices for goods and services rise, as measured by the CPI-W, Social Security benefits are increased by the calculated COLA percentage.
The purpose of COLAs is to protect seniors and other Social Security beneficiaries from losing purchasing power when prices rise. They ensure that benefits keep pace with inflation over time. COLAs are also applied to Supplemental Security Income (SSI) and railroad retirement benefits.
When did Social Security start automatic COLAs?
Up until 1972, Social Security benefits were increased sporadically by special legislative action. The 1972 Social Security Amendments instituted automatic COLAs based on the CPI-W to be applied beginning in 1975. This ensured that benefits would be adjusted each year for inflation without needing additional legislation.
The formula to calculate the COLA was slightly modified in 1977 and remains largely unchanged today. The COLA is based on the percentage increase in the CPI-W from the third quarter average of the last year a COLA was determined to the third quarter average of the current year. If there is no increase, there is no COLA.
Are COLAs a separate payment from Social Security benefits?
COLAs are not paid out as a separate payment from the regular Social Security benefit amount. The COLA is simply an annual calculation applied to the existing Primary Insurance Amount (PIA). For example:
| Year | Original PIA | COLA % | Updated PIA with COLA |
| 2022 | $1,000 | 5.9% | $1,059 |
| 2023 | $1,059 | 8.7% | $1,150 |
The higher Updated PIA reflecting the COLA becomes the ongoing monthly benefit paid. Rather than receiving two checks, one for the original PIA and another for the COLA increase, beneficiaries simply receive the higher adjusted amount going forward. The COLA is not an additional payment on top of the base benefit.
When are COLAs announced and paid?
The COLA increase for the upcoming year is typically announced in October by the Social Security Administration. For example, the 2023 COLA was announced on October 13, 2022. However, the COLA is not actually applied to benefits until January payments.
For instance, if a beneficiary has been receiving $1,000 per month in Social Security, they would continue to receive $1,000 monthly payments through December 2022. Then starting with the January 2023 benefit, they would receive the new increased amount of $1,086 per month (using a hypothetical 8.6% 2023 COLA).
Key takeaways on COLA timing:
- COLA amount is announced in October
- COLA is applied to payments starting in January
- There are no retroactive payments for COLA increases
This means there are no retroactive COLA payments that apply back to earlier months of the current year. Beneficiaries only begin receiving the higher COLA amount in January going forward.
Does the COLA increase stay in effect permanently?
Yes, after a COLA percentage is applied to Social Security benefits, the increased amount becomes the new permanent benefit level. Beneficiaries do not revert back to their previous lower payment.
For example, if a retiree had an original PIA of $1,000 that grew to $1,086 with the 2023 COLA, they would continue receiving $1,086 per month in 2024 and beyond (unless impacted by a future COLA). The benefit level does not decrease again.
Of course, the tradeoff is that inflation in subsequent years may begin eroding the purchasing power of that new higher benefit level. But the base benefit payment itself does not decrease again just because a new calendar year begins. COLAs permanently adjust the benefit formula used to arrive at monthly payment amounts.
Can there ever be zero COLA like in 2010, 2011?
Yes, it is possible to have a zero COLA adjustment for a given year if inflation is negligible. Since COLAs were first introduced in 1975, there have been three years when Social Security benefits did not receive a COLA:
- 2010: 0% COLA
- 2011: 0% COLA
- 2016: 0% COLA
In these years, the CPI-W measured no statistically significant increase in inflation from Q3 to Q3 of the previous year. So Social Security benefits remained at existing levels with no upward adjustment.
However, in years following a zero COLA, the COLA calculation essentially catches up. The COLA is determined based on inflation since the last time a COLA was applied rather than just year-over-year.
For example, after two consecutive zero COLAs in 2010 and 2011, beneficiaries received a 3.6% COLA in 2012. This COLA represented inflation adjustments for both 2011 and 2012.
Do COLA increases reduce overall Social Security funding?
COLAs do not reduce Social Security’s total trust fund reserves or ability to pay scheduled benefits. Cost-of-living adjustments are considered in the system’s annual accounting and 75-year actuarial projections.
COLAs do meaningfully impact the annual Social Security budget paid out of current tax revenues:
- In 2022, COLA increased Social Security costs by approximately $22 billion
- An estimated $70 billion in added 2023 benefit costs stems from the 8.7% COLA
So from a short-term budget perspective, large COLAs do result in materially higher annual payouts from Social Security’s two trust funds (OASI and DI). However, the program’s long-term solvency is not seriously impacted. Eliminating COLAs would improve the outlook but only modestly.
According to Social Security’s Chief Actuary, eliminating COLAs would close just one-fifth of the program’s long-range funding shortfall. Other reforms like raising the retirement age or increasing payroll taxes would have a much larger impact.
Can the COLA formula be modified by Congress?
Yes, Congress has the ability to change the COLA formula by passing new legislation. Proposals have included things like:
- Adopting an alternate inflation index (CPI-E) specifically for seniors
- Implementing a “three-year lookback” to smooth out unusual swings
- Applying a flat 2% or 3% annual adjustment regardless of actual inflation
To become law, any changes would need to pass both the House and Senate and receive the president’s signature.
Some experts argue the current CPI-W index used for COLAs does not fully reflect seniors’ higher health care costs. However, adopting a less conservative measure like CPI-E could also accelerate trust fund depletion, requiring other reforms.
Do COLA increases mean higher taxes on benefits?
Yes, for retirees whose income exceeds certain thresholds, a higher Social Security benefit resulting from COLAs can trigger increased taxation of benefits. IRS rules mean individuals with combined income over $25,000 ($32,000 married filing jointly) have to pay taxes on up to 50% of benefits. Above $34,000 individual / $44,000 joint, up to 85% of benefits may be taxable.
So if a Social Security COLA boosts a senior’s total income into those ranges, the share of benefits subject to federal income tax could rise. They may have to pay IRS taxes on Social Security income that was previously tax-free for them prior to the COLA bump.
However, a COLA by itself should not create an additional tax burden since the IRS brackets are also adjusted for inflation each year. For low to moderate-income seniors already paying taxes on benefits, a COLA shouldn’t significantly change the effective tax rate. The income brackets are simply adjusted upward to match the benefit increase.
Conclusion
In summary, Cost-of-Living Adjustments do not exist as separate payments from the underlying Social Security retirement, spousal, or disability benefits. A COLA is essentially just a mathematical increase applied to the existing benefit formula. The purpose is to maintain seniors’ purchasing power despite rising inflation.
While COLAs do not have a major impact on Social Security’s solvency, they significantly increase total payouts in years when inflation accelerates. Occasional zero COLA years also demonstrate benefits are not automatically increased every year across the board. But in general, COLAs provide an annual adjustment to keep pace with the cost of goods and services.