Your wallet may get a little thicker next year thanks to Social Security's annual cost-of-living increase, or COLA.

Every fall, the Social Security Administration determines whether to award a COLA increase depending on how much Americans are paying for specific goods or services. This year, its annual review could result in the biggest increase to Social Security income in over a decade. Read on to learn how Social Security decides how to award COLA increases and how big the increase to your income could be in 2022.

Three seniors blowing confetti out of their hands.

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Social Security COLA calculation

It used to take an act of Congress (literally) to increase Social Security income, but that changed in 1975 when Washington, D.C. gave the Social Security Administration a template for determining cost-of-living increases annually.

The decision to award a COLA increase is based on the annual price change in various goods and services using the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. 

Specifically, the monthly CPI-W data for the third quarter of the current year are compared to the third-quarter data from the most recent year in which a Social Security increase was awarded. For example, if an increase wasn't awarded last year, but it was awarded two years ago, then the current year's third-quarter CPI-W would be compared to the third-quarter numbers from two years ago.

If the third-quarter CPI-W has increased over the comparison period, then Social Security income is increased by the exact amount of the change in CPI-W. If the CPI-W is equal to or lower than the comparison period, then Social Security income is left unchanged.

For instance, the CPI-W in the third quarter of 2020 was 1.3% above the CPI-W in the third quarter of 2019, so Social Security recipients saw their income increase 1.3% for 2021.

Will there be a COLA increase in 2022?

Since the Social Security Administration uses third-quarter CPI-W, we won't know for sure if there will be a COLA increase until September's CPI-W is reported in October.

Nevertheless, the CPI-W that's been reported so far in 2022 is encouraging. CPI-W has increased this year at its fastest rate since 2008, and inflation suggests Social Security recipients could be about to nab their largest pay raise in nearly 30 years.

Through July, the average CPI-W over the past three months is 5.9% higher than the same period in 2020. If this was third-quarter data, then Social Security recipients would be in store to pocket a corresponding 5.9% increase to their benefits in 2022. For perspective, the average Social Security increase over the past five years has been just 1.6%, and you have to go all the way back to 1982, when a 7.4% increase was awarded, to find one that's bigger than 5.9%.

Consumer Price Index for Urban Wage Earners
and Clerical Workers (CPI-W)
Year May June July Average
2020 249.521 251.054 252.636 251.070
2021 263.612 266.412 267.789 265.938
Percent Change YoY       5.9%

Data source: Social Security Administration. YoY = year over year.

A senior looking into a wallet.

Image source: Getty Images.

Don't spend it all yet, though

The rebound in inflation this year could moderate over the next two months if increasing concern over the COVID delta variant taps the brakes on consumer spending. It's unlikely inflation will slow so dramatically it eliminates the possibility for a COLA increase next year, but anything can happen.

If you collect Social Security, then you should also keep in mind there's a good chance a lot of any COLA increase you're awarded this year may flow right back out of your bank account in the form of higher expenses, including premiums for Medicare Part B. If you file jointly and your modified gross income two years ago was $176,000 or less, then you're paying $148.50 per month for Part B coverage in 2021, up 2.7% from 2020.

It's also important to remember that while a 5.9% increase is welcome, the effect of the increase in absolute dollars isn't likely to dramatically change anyone's financial position. In 2021, the average person is receiving $1,555 per month in Social Security benefits, according to Social Security's statistical snapshot in June. So a 5.9% increase only translates into about $23 per week in extra income for eligible retirees, suggesting it's wise to consider other tips to maximize your Social Security, too.