Social Security Cost of Living Adjustment (COLA) Throughout the Years
Social Security is a cornerstone of financial security for millions of Americans. One of the essential features of Social Security benefits is the annual Cost of Living Adjustment (COLA), which ensures that the purchasing power of benefits keeps up with inflation. The Social Security administration has announced a 2.5% COLA increase for 2025. Let’s explore what that means for you and how COLA has evolved over the years.
The Origins of Social Security COLA
Social Security was introduced during the Great Depression, with the Social Security Act signed into law by President Franklin D. Roosevelt in 1935. Initially, the benefits were fixed and did not account for inflation. However, as the cost of living increased over time, the purchasing power of fixed benefits diminished, leading to the need for adjustments.
The first automatic COLA was implemented in 1975. Before this, Congress had to enact special legislation to increase benefits, which led to irregular and often inadequate adjustments. The introduction of automatic COLA was a significant reform designed to provide beneficiaries with predictable and regular benefit increases to match inflation.
How COLA is Calculated
The COLA is determined by the Social Security Administration (SSA) based on changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).2f The CPI-W measures the average price change over time for a basket of goods and services consumed by urban wage earners and clerical workers.
The COLA calculation compares the average CPI-W for the current year's third quarter (July, August, September) with the average CPI-W for the same quarter of the previous year.3 If there is an increase, the percentage increase is applied to Social Security benefits for the following year. If there is no increase or a decrease, benefits remain unchanged, ensuring that beneficiaries do not experience a reduction in nominal benefits even if deflation occurs.
Organizations such as the Senior Citizens League Senior believe the CPI-W doesn’t accurately capture life expenses as experienced by seniors and retired people. Instead, they propose using the CPI-E, which specifically tracks prices for goods and services purchased by seniors.
Historical Trends in COLA
Over the years, COLA adjustments have varied significantly, reflecting different periods' economic conditions and inflation rates.
Let's explore some key periods in the history of Social Security COLA:
1970s
The late 1970s saw some of the highest COLA increases in history due to rampant inflation. The annual inflation rate doubled to more than 12 percent from 1969 to 1974. In 1980, the COLA was a staggering 14.3%, reflecting these high inflation rates.
1980s to 1990s
The 1980s and 1990s witnessed more moderate and stable COLA increases. The economic policies implemented during these decades helped control inflation, resulting in more predictable and minor adjustments. For example, the COLA in 1985 was 3.1%, and in 1995 it was 2.6%. These adjustments mirrored the period's lower and more stable inflation rates.
2000s
Significant economic events, including the dot-com bubble burst, the housing market collapse, and the Great Recession, marked the 2000s. These events influenced inflation and, consequently, COLA adjustments. In 2009 and 2010, there was no COLA increase due to negative inflation rates during the recession, reflecting the economic downturn.
2010s to Present
In the post-recession era, the economy gradually recovered, but inflation rates remained relatively low. This period saw modest COLA increases, often around 1-2%. For example, in 2017, the COLA was 2%, and in 2020, it was 1.3%.
Recently, COLA has been higher than in the late-2010s. In 2022, the COLA was 8.7%; in 2023, it was 3.2%.
2025 COLA Announcement
Some were disappointed at the announcement of a 2.5% COLA for 2025. This is the lowest adjustment since 2021, a decrease of 0.8% from the 2024 COLA, and below the 10-year average of 2.8%. Moreover, it appears as though it will lead to a reduction in purchasing power for the second year in a row. While this matches the inflation captured by the CPI-W, the CPI-E 2025 adjustment would be 3.0% rather than 2.5%, and the past two years would have been cumuatively 7.1% rather than 5.8%.
The Social Security Cost of Living Adjustment attempts to ensure that benefits to keep pace with inflation and safeguard the purchasing power of millions of Americans. COLA has evolved from the mid-1970s to today to reflect changing economic conditions and inflation rates. As always, HCM will stay abreast of this and other federal changes and ensure this information is incorporated into your comprehensive financial plan.