Prices for consumer goods generally rise over time. For example, the cost of an average home 20 years ago would have been about $194,000 compared to the average price in 2019 of $377,000. Similarly costs for utilities, food, and other basic life needs also increase.
To account for this, the Social Security Administration adjusts the amount that it pays to beneficiaries of Social Security and Supplemental Security Income. When there is such an increase, it also raises the amount some recipients can earn without having money deducted from their benefits. This is known as a Cost of Living Adjustment, or COLA. Without COLA, people on a fixed income could eventually find themselves short of meeting their basic monthly expenses.
How COLA works
When an individual is considered eligible to receive SS payments, the administration does a calculation based on the person’s financial situation to determine how much money they should receive every month. (See how to do that calculation using a Social Security benefits calculator.)
Part of that calculation is based on the current cost of living—how much it costs to pay for necessities. Every year the administration uses data about how much the cost of living has increased to determine how much they should increase recipients’ Social Security payments so that the amount of money they receive can still purchase the same value of rent, groceries, and so on.
How does the Bureau of Labor statistics data impact COLA
To factor in a rise in the cost of living, the Social Security Administration relies on data collected by the Bureau of Labor Statistics. The BLS collects information on the cost changes of a “basket of goods” that might include rent prices, prices on specific groceries such as eggs, milk, and bread, plus prices of utilities, healthcare and other expenses.
The data goes into an index of prices, known as the Consumer Price Index. The best known CPI is the CPI-U which takes into account income and spending for all urban wage earners–about 93 percent of the population. The CPI, as it is commonly known, is considered an indicator of how the economy is functioning and how well government economic policy is working. A spike in the CPI, for example, means potential inflation; and a precipitous drop means potential recession.
Social Security, however, uses a parallel metric called the Consumer Price Index for Urban Wage Earners and Clerical Workers or CPI-W. The CPI-W is meant to reflect the spending habits of consumers in homes where more than half the income comes from clerical or wage occupations, and at least one of the household’s earners has been employed for at least 37 weeks during the previous 12 months. The CPI-W population is a subset of the CPI-U population and represents about 29 percent of the total U.S. population.
Social Security bases the amount of the COLA for recipients on the changes in the CPI-W.
What is the announced 2020 adjustment increase
The Social Security Administration announced a COLA of 1.6 percent for 2020 for nearly 69 million Americans who receive Social Security and Supplemental Security Income (SSI) benefits. Increased payments to more than eight million SSI beneficiaries will begin on December 31, 2019, and benefits payable to more than 63 million Social Security beneficiaries will begin in January 2020.
When there is a COLA, it automatically triggers an increase in the amount beneficiaries can earn without SSA deducting any of their earnings. People under “full” retirement age were able to earn $17,640 in 2019 without any deductions from their benefits. In 2020, they will be able to earn $18,240 without deductions. The SSA deducts $1 from benefits for each $2 earned over $18,240.
The earnings limit for people turning 66 in 2020 will increase to $48,600. The administration deducts $1 from benefits for each $3 earned over $48,600 until the month the worker turns age 66.
There is no limit on earnings for workers who are “full” retirement age or older for the entire year.
How is COLA calculated
Each quarter, 24,000 consumers from around the country provide information on their spending habits to the BLS through a survey. In addition, another 12,000 consumers keep diaries listing everything they bought during a two-week period to provide information on frequently purchased items. From this data, the BLS assigns a weight, or importance, to various categories.
The metric used by Social Security to determine COLA, CPI-W, places slightly more weight on goods and services such as food, apparel, and transportation, and slightly less weight on housing, medical care and recreation.
Beyond collecting the information from households, and also tracking 80,000 goods per month in stores, the BLS does complicated calculations about sizes, brands, serving amounts, and other detailed information on given products. Obviously, for example, since there are so many kinds of cheese, it cannot just calculate a rise in the price of cheese.
The CPI-W is not likely to mirror any one individual’s experience with prices. It’s an aggregate. It takes the price increases for the items in the “basket of goods” and averages them, assigning various weights to various items, to come up with what the COLA should be.
The administration compares the average CPI-W for July-September of the most recent year a COLA was determined to the average CPI-W for July-September of the current year. If there is a percentage increase above .05 percent, that’s the percentage by which Social Security benefits will rise beginning December of the current year.
History of COLA
Congress enacted the COLA as part of the Social Security Amendments of 1972. Before that, Social Security Benefits could not be increased except by an act of Congress on an ad hoc basis. Inflation was high in the early 1970s, so the provision required that an automatic COLA would only be triggered if the increase in the CPI-W was at least 3 percent. By the mid-1980s, inflation was waning, and the 3 percent trigger no longer seemed a reasonable metric. Congress did away with it in 1986.
When there’s a COLA for Social Security benefits, other increases are automatically triggered. One is the cap on the amount of wages and self-employment income subject to Social Security payroll tax. Another is the cap on how much a person not in full retirement can earn before their benefits are reduced.
Recent Cola adjustments (2018, 2019)
The COLA adjustment for 2020 is lower than it has been in recent years. In 2019, the COLA was 2.8 percent. In 2018, the COLA was 2 percent. These each reflected the Consumer Price Indexes of the third quarter of the previous year.
How does the 2020 COLA adjustment impact buying power?
Let’s say a Social Security beneficiary receives $2,000 a month. At the time that amount was approved for the beneficiary, prices for everything might have been 7 percent lower. So, depending on where you live, a week’s worth of groceries that now costs $100 used to cost only $93. But if you add up that extra $7 every week for 52 weeks, you’re now paying $364 more per year on the same groceries you bought before. Without a COLA you can’t afford to buy the groceries you once bought.
And that’s just one category. BLS looks at more than 200 categories in the groups of food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and various government-charged user fees, such as water and sewerage charges, auto registration fees, and vehicle tolls. Imagine if you spend $35,000 a year on all of those things. Now your 7 percent increase is $2,450. Without a COLA, you couldn’t afford your basic expenses.
The BLS has reported that the CPI for April 2018 to April 2019 rose 2 percent, which may mean another COLA in the future. And while the math behind it is complicated and beneficiaries will not all see exactly a 1.6 percent increase, they should see an increase in their benefit amount by January of 2020.