How COLAs Are Calculated -- and Why the Formula May Not Reflect What You Actually Pay

If you've been on Social Security for a few years, you've probably settled into a familiar pattern: You eagerly anticipate the next year's cost-of-living adjustment (COLA), but when the benefit boost arrives, you don't feel like you're actually getting ahead, or even keeping up with where you were. So you set your sights on the next year's COLA, hoping that one will be better.

You're not alone in doing this, and you're not imagining things, either. There's a real reason your COLAs don't seem like they're keeping pace with your expenses, and it has to do with how the Social Security Administration calculates them in the first place.

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COLAs aren't based on senior spending habits

If someone tasked you with deciding how future Social Security COLAs should be calculated, you might look at how much the average senior's spending has increased from one year to the next and make that amount the COLA. That's not what the government did.

When it created the COLA formula we use today, it based COLAs on average third-quarter inflation rates as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This index only includes households where at least one member has been employed for at least 37 weeks during the previous year, and where at least 50% of household income comes from wage earnings. That rules out most retiree households by default.

Since the CPI-W focuses on the spending habits of workers, many of whom are younger and healthier than retirees, it can cause COLAs to underweight some key expense categories for seniors, such as healthcare, which often rises faster than the standard inflation rate. The result is a COLA that increases benefits without increasing buying power.

The ironic thing is that there is an index for specifically tracking senior spending habits: the Consumer Price Index for the Elderly (CPI-E). Many seniors and some members of Congress have called for the government to switch to the CPI-E for COLA calculations. This would increase COLAs in most years.

Why don't we base COLAs on the CPI-E?

Changing to the CPI-E would require Congress to update the Social Security COLA formula. That's difficult because of partisan politics, but also because higher COLAs would increase the program's expenses. This could cause the trust funds, which are already expected to be depleted in 2032, to run out even sooner. That could force a 22% benefit cut unless the government intervenes.

It doesn't mean we'll never see a change to the CPI-E, but I wouldn't expect it to happen for a little while. We'll likely have to wait until Washington decides on a plan to keep Social Security sustainable before changes to the COLA formula occur.