The Key Fact Retirees Get Wrong About the Social Security Cost of Living Adjustment

Social Security is one of the most important sources of income for retirees. One reason these benefits can be so valuable to seniors is that the program includes inflation adjustments. These come in the form of cost-of-living adjustments, or COLAs, that happen most years.

Unfortunately, there is a very common misconception around COLAs that could end up hurting seniors. Here's what it is.

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Many people get this basic COLA fact wrong

The common misconception about the COLA has to do with what Social Security cost-of-living adjustments (COLAs) actually mean for retirees. Often, the COLA is referred to as a "raise." And many seniors are excited to see how much their benefits will increase. A large COLA is also sometimes touted as a good thing.

This is understandable because a COLA does make benefit checks bigger, and people like getting more money. Plus, in the working world, when your monthly paycheck goes up, that's typically because of a raise that increases your standard of living.

The issue, however, is that COLAs are not a raise. They are simply a benefit adjustment aimed at helping Social Security checks to keep pace with inflation. Seniors do not typically end up better off because of a large COLA, and they don't get more buying power when the amount of their Social Security payment increases because of it.

A bigger COLA is actually bad news for retirees

The truth is, those hoping for a larger COLA fundamentally misunderstand the reason for, and the implications of, this change. COLAs are calculated by comparing the cost of a basket of goods and services. Specifically, the year-over-year increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is used to calculate the COLA.

So when benefits increase substantially, it means CPI-W shows inflation is surging. The only way for retirees to collect a large COLA is for prices to increase substantially. A larger COLA won't give seniors more buying power, since it's calculated to help them maintain it. And since most seniors get some of their income from retirement plans that don't automatically adjust for inflation, retirees could see their other income sources lose ground because of the high inflation that led to the bigger COLA.

What's more, the Senior Citizens League's research shows that the use of CPI-W to calculate COLAs results in retirees not actually keeping pace with inflation, but instead gradually losing buying power. The real value of Social Security has declined by 13.7% since 2016. Ultimately, this means retirees could be hurt in multiple ways due to a large COLA. Their other income sources will lose buying power, and Social Security may as well.

While you'll still see COLAs called "raises," you generally should keep these basic facts in mind during your retirement planning to better understand how these cost-of-living adjustments will actually impact your financial security moving forward into the future.

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