Calculating Your Cost of Living Adjustments for Social Security

200px-Double_ColaAs you are probably aware, each year your Social Security benefits can be increased by a factor that helps to keep up with the rate of inflation – so that your benefit’s purchasing power doesn’t decrease over time.  These are called Cost Of Living Adjustments, COLAs for short.  The last increase was for 2009, an increase of 5.8% – for 2010 there was no COLA.  But how are those adjustments to your benefits calculated?

Calculating the COLA

There is an index, compiled and managed by the Bureau of Labor Statistics, called the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W.  This index, or rather changes to the index, gauges the fluctuations in those wages over time.  Each December, SSA looks at the CPI-W level for the third quarter of that year (averaging July, August and September), and compares it to the same level for the previous year’s third quarter.  The percentage of increase, if any, is then used as COLA for Social Security benefits.  This is an automatic process, no action is required by Congress to enact the increases over time. As an example, the CPI-W average for the third quarter of 2009 was 211.001, and for the same period in 2008 the average was 215.495.  Comparing the two amounts we see that there has actually been a decrease in the CPI-W.  This is why there was no COLA for Social Security benefits in 2010. For the most recent example of an increase, the CPI-W for the third quarter of 2007 was approximately 203.681.  When you compare that number to the 2008 third quarter figure (215.495), you come up with an increase of 5.8% – which is what the COLA was for 2009.

How it’s applied

So, simple enough, right?  We have the COLA, just multiply that by your benefit, right?  Not so fast there, calculator-breath.  Staying true to form, SSA has a more complicated method to determine what your benefit will be each year. As we mentioned before in the article on Calculating the Social Security Retirement Benefit, when you apply for benefits affects your benefit permanently.  All benefit calculations begin with your Primary Insurance Amount (PIA), and are adjusted up or down depending on whether you apply for benefits after or before Full Retirement Age (FRA), correspondingly. For example, if your Full Retirement Age is 66 and your PIA is $2,000, and you’ve filed for benefits at age 62, your actual benefit amount began at 75% of the PIA, or $1,500.  The COLA is applied to your PIA, and then your reduction applied to that amount.  So for a COLA of 3%, your new benefit amount would be $1,545 – calculated as PIA ($2,000) times COLA (3%) equals $2,060, times the reduction amount of 75%, for a total of $1,545. Similarly, if you delayed your benefit to age 70, your benefit would begin at 132% of your PIA, or $2,640.  For our example increase of 3%, your new benefit would be $2,719.  Amounts are always rounded down to the next lower dollar.
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About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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