Cost of living adjustments (COLA) are given to offset the effects of inflation. As expenses for goods and services go up, salaries, too, must rise to keep pace with these increases, otherwise your income would no longer cover the things you need to thrive.
Social Security benefits incur annual COLA, too. Some 62.5 million people rely on these monthly payouts, and 70 percent of them are retired, which means their Social Security accounts for the bulk of their income. Think of COLA as the annual raise most workers get to supplement inflation; it works the same way for Social Security.
The federal government implemented a system for determining the annual COLA increase in 1975. It bases the rate of inflation on the average third-quarter readings from the Consumer Price Index for Urban Wage Earners and Clerical Workers, comparing the current year with the year before.
If the year-to-year average rises, as it has every year save three of the past 43, then a COLA is implemented that corresponds to the percentage gain, rounded to the closest 0.1. If an increase does not occur, then the rates remain the same as the previous year.
This sounds like a reasonable way to factor COLA, right? Well, it wasn’t always like that. Up until the 1970s, they were handed out in a rather haphazard manner that once even resulted in an astounding year-to-year payout increase of 77 percent! Just imagine being on the receiving end of that bump. Let’s take a look at how the current system evolved and some of the other outrageous COLAs over the years.
The Early Years of Social Security COLAs
So how did that 77 percent jump come about? From 1940, when the first Social Security payments were made, to 1950, benefits did not see a single year-to-year increase. Social Security was created in 1935, as threats to retired Americans’ economic security arose during the Great Depression.
But the government failed to make provisions for elevating that money, and so by 1950, those over 65 once more were struggling as their income did not keep up with inflation. So, in 1950, Congress authorized a boost of 77 percent to payouts. Two years later, it enhanced those payouts again, this time by a more modest 12.5 percent, followed by another 13 percent in 1954.
From 1950 to 1954, Social Security recipients saw their payouts soar by 125 percent. That certainly was not a sustainable clip, but by that point the earlier deficits had been accounted for.
How Automated Social Security COLA Came About
After the accelerated payments of the early 1950s, Congress did not seem to learn its lesson. From 1954 to 1975, it voted to increase benefits a mere eight times. Once again, the payouts were sporadic and tended to be high to offset earlier failure to act, as evidenced by these numbers:
1970: 15 percent rise
1971: 10 percent rise
1972: 20 percent rise
By comparison, between 1992 and 2016, the annual increase was greater than 3.4 percent just four times. In 1975, Congress finally passed legislation setting the current COLA system in place, bringing to an end the uneven and unreliable system that had been in place for more than three decades. It provides for measured and logical COLAs that won’t strain the system.
Social Security and its accompanying intricacies can be confusing for those who are not well-versed in its history. Need assistance in this area? Contact Jay to learn more about Social Security and planning for your retirement.