What Are COLAs and How Do They Affect Retirement

What Are COLAs and How Do They Affect Retirement Fitzwilliams Financial

If you are currently receiving Social Security or you are considering how Social Security might factor into your retirement plan, it’s important for you to understand what COLA stands for. You may have seen the acronym in various information about Social Security, and you may have wondered what it meant. Well, let’s answer your questions about the term.

What is a COLA?

COLA stands for “cost of living adjustment.”[1] It’s an automatic increase in the payout of Social Security benefits that is meant to counter inflation. [1] The amount Social Security is increased by is based on the CPI-W, which stands for the “consumer price index for urban wage earners and clerical workers.”[2] Essentially, the CPI-W is calculated using the prices for common goods that people purchase in their everyday lives, such as food, clothing, medical care, recreation, and other common purchases.[2] It’s a way for the government to track the increase in the general cost of living for most people.

How Do COLAs Work?

So, in a nutshell, the COLA is a way that your Social Security will be adjusted automatically to increase based on the current price of goods on the market.

One of the more important things to consider when it comes to your retirement and the COLA is that the longer you wait to receive your benefits, the more the COLA will increase your payouts.[3] You are allowed to withdraw your Social Security at 62, but you will get a permanently reduced payout.[3] This reduction in payout will cause the COLA increases in your payments to be less than if you had waited to claim your social security at your full retirement age.[3]

Here’s an example to illustrate this point:

If you receive $10,000 yearly in Social Security benefits at full retirement age, an 8% COLA increase will cause you to receive an additional $800 a year for the rest of your life. If you claim your Social Security early and you get $7,000 in Social Security, an 8% COLA increase will cause you to gain an additional $560 a year for the rest of your life. So, claiming early can not only decrease your initial payouts, but it will also decrease your COLA adjustments as well.

Retirement has a lot of rules and different elements that it can be important to know. If you are looking for a guide to help you navigate your retirement planning, consider reaching out to one of our professionals today for a complimentary review of your finances.