Social Security Inflation Adjustments (COLA and Wage Indexing)

In the last two weeks I’ve received an assortment of questions about how, exactly, Social Security inflation adjustments work.

In brief, there are two types of inflation-indexing that occur with Social Security: indexing of your earnings history and indexing of retirement/disability benefits (and other benefits based on retirement/disability benefits).

Indexing Your Earnings History

When calculating your “average indexed monthly earnings” (i.e., the earnings history that is used to determine your retirement or disability benefit), all earnings that occur prior to age 60 are indexed to age-60 dollars.* This indexing is not based on price inflation but rather on wage inflation, as measured by the national average wage index.

For example, if the national average wage was twice at high in your age-60 year as in your age-40 year, your earnings from age 40 would be included at twice their actual dollar amount when calculating your earnings history.

Earnings after age 60* are not indexed. As it turns out, this usually lets them count for more than if they were indexed (because if they were indexed, they’d have to be indexed to age-60 dollars, which would be a downward indexing in most cases).

Cost of Living Adjustments (COLA)

Beginning at age 62 (or, if earlier, the year in which you die or become disabled), your primary insurance amount (i.e., the amount of your monthly retirement benefit, if you were to file for it at exactly full retirement age), begins to be indexed upward each year for price inflation, as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).

Specifically, the calculation is done by comparing the average monthly CPI-W from the third quarter of the current year to the average monthly CPI-W from the third quarter of the last year for which there was a COLA.

There are two key points about this cost of living adjustment.

First key point: Because the COLA is an adjustment to your PIA, it also affects the benefit of anybody else who receives benefits on your work record, such as a spouse or child.

And second: Your PIA will begin to receive a cost of living adjustment at 62 regardless of whether or not you have retired and regardless of when you file for benefits. (I’ve encountered many people who thought that you had to claim benefits in order to get your COLA — making it a point in favor of claiming early — but that’s not true at all.)

*In the event of death or disability prior to age 62, rather than using age 60, the calculation uses the year that is two years prior to the year in which you die or became disabled. That is, earnings prior to that particular year will be indexed to that year, and earnings after that year will not be indexed. For example, if you become disabled at age 47, earnings prior to age 45 would be indexed to age-45 dollars. Earnings after age 45 would not be indexed.