If you are collecting Social Security, chances are good that you're already aware of the fact that you get a cost-of-living adjustment (COLA) in most years. However, you may not be aware of the specific details for how this adjustment to your benefits works.
Since this benefit increase is critical to helping you maintain your buying power throughout retirement, it's helpful to know how a COLA is calculated. This knowledge will allow you to both estimate the amount you'll receive each year and understand why the COLA may fall short of your expectations.
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This is how the Social Security COLA is calculated
The COLA is sometimes called a Social Security raise, but that doesn't quite capture their purpose. COLAs are meant to help your benefits keep pace with inflation. As a result, the COLA formula is based on a specific measure of inflation and provides a benefits increase only if inflation is occurring.
The Bureau of Labor Statistics (BLS) plays an important role in this process. The BLS maintains different consumer price indexes that track the prices of goods and services. The price index used in COLA calculations is called the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).
The Social Security Administration looks at year-over-year changes to the CPI-W. It does this specifically for data from the third quarter of the year (the months of July, August, and September). The COLA equals the percentage increase in the average CPI-W during this critical three-month period.
Normally, the September data is available in mid-October, so the announcement of the COLA is made at that time. However, as a result of the government shutdown, the data collection was delayed, and the CPI-W numbers for September won't be released until Oct. 24, 2025. At that time, it will become possible to measure how much the average third-quarter CPI-W reading has gone up compared with same period last year, and the resulting change will determine how big a COLA retirees will get.
There are some flaws in the formula
While using a consumer price index to measure inflation and award COLAs makes good sense for Social Security beneficiaries, there is a big flaw in the current methodology. The issue is that the consumer price index chosen for the calculation measures the spending habits of a different group than seniors: urban wage earners and clerical workers.
These individuals tend to spend differently than retirees, devoting less money to critical areas like housing and healthcare, where industry-specific inflation tends to be higher than overall inflation. The end result is a COLA that often doesn't adequately represent the price increases retirees face each year.
This has led to benefits declining in buying power over time, leaving many retirees more reliant on their retirement plans as their benefits buy less and less each year. Of course, retirees do need to be careful not to draw down their 401(k) or other retirement plans too quickly.
Possible fixes have been suggested for this issue, including changing to a consumer price index for the elderly. While one exists, it's an experimental index with methodological limits, and the switch would also make Social Security's precarious financial situation even worse.
So, for now, changes to the CPI-W remain the key factor that determines the size of any COLA. Retirees just have to wait until this number is released in late October to see what their budgets will look like in the coming year.
