The Social Security Administration recently announced a 2017 cost-of-living adjustment, or COLA, of 2%, meaning that Social Security recipients will receive this increase to their monthly benefit checks staring in December 2017. This is the highest COLA in six years and is welcome news for many American retirees.

However, a 2% COLA is actually quite low by historical standards, and what's more, Medicare costs could offset most of the increase, and the expenses seniors incur may be rising faster than the COLA would suggest. Here's a brief history of Social Security cost-of-living adjustments, how the COLA is determined, and why this year's 2% increase may not be much of an increase at all for most retirees.

Social Security card in spread-out pile of 20 dollar bills.

Image source: Getty Images.

How the COLA is determined

Social Security cost-of-living adjustments are determined by inflation. As the costs of goods and services increase, the idea is that Social Security benefits should increase by the same percentage, so that retirees are able to maintain their purchasing power.

Specifically, Social Security COLAs are based on the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. This is an index that tracks the prices of certain items that are intended to be representative of working households.

It's also worth noting that there is a Consumer Price Index specifically designed to track expenses for elderly Americans, the CPI-E, although this is not currently used for Social Security COLA. It considers certain categories of expenses differently from the CPI-W -- for instance, elderly Americans spend twice as much on medical care as consumers considered in the CPI-W. Since the early 1980s, the CPI-E has been rising at an average rate that's 0.2% greater per year than the CPI-W, so for this reason, many experts believe that seniors are losing purchasing power slowly, despite the intentions of the annual adjustments.

A brief history of Social Security COLA

The modern COLA method has been in effect since 1975. Before that, Social Security benefit increases were determined by legislation, and not by a specific formula.

There has been tremendous variation in the annual COLA over the years. Since 1975, there have been annual adjustments as high as 14.3% in 1980, or as low as 0%, which has happened three times -- all within the past decade. In the average year, the Social Security COLA has been 3.75%. So this year's increase of 2% is just over half of the historical average.

What this could mean for American seniors

The average retired worker collects a Social Security benefit of about $1,371 per month, so the 2% COLA translates into an increased monthly benefit of $1,398, or $27 more.

Many retirees collect significantly more than the average and will therefore get much larger raises. In 2017, the maximum Social Security benefit for someone who claimed at full retirement age was $2,687, so this would correspond to a COLA of about $54. People who waited beyond full retirement age could be receiving even more -- up to $3,538 per month in the case of someone who waited until age 70 to claim. That means it's possible for some beneficiaries to receive a $71 monthly COLA beginning in December, or about $850 per year.

2017's COLA may not be much of an increase after all

Even though this year's COLA isn't on par with the historical average, it still may seem like good news to Social Security recipients. After all, if you were receiving $1,400 per month, this means your check will rise by $28.

However, as my colleague Sean Williams wrote, there's a good chance that most, if not all, of your 2% increase could be swallowed up by increasing Medicare Part B premiums. We won't know for sure until the 2018 premiums are announced, but it looks pretty likely. Between this and the fact that the CPI-W tends to rise slower than the actual rate of inflation seniors experience, it's fair to say that this year's Social Security COLA won't be as much of a "raise" as it seems.

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