If there is one thing that you can count on when it comes to retirement, that is that the cost of living will increase by then, and will continue to increase during your retirement years. This is why the Cost of Living Adjustment, also known as COLA, is one of the most important elements of your Social Security Benefits. COLA is a method of which your monthly benefits are adjusted for the expected cost of living increases.
The Cost of Living increase adjustments that you get with your Social Security benefits are important to help you meet your living expenses. This adjustment is not something that you will likely get with your pension, which will usually remain at a fixed payment amount.
Of course when you look at inflation over a two or three year period, this adjustment may not seem all that significant, but if you look at inflation over a couple of decades, the value of this adjustment becomes obvious.
The Purpose of COLA
These income adjustments are not to help retirees better their living standard; instead it is intended to help them maintain their current standard of living. If there were 3% inflation each year, you would probably need about 30% more money after 20 years just to maintain your current standard of living. With just 4% increase, you would need twice the amount of your current income to be able to meet your current living expenses.
Due to laws that have been in place since 1973, Social Security benefits are automatically increased to meet inflation. The amount that those benefits increase is determined by a formula that measures the rate of inflation each year. The increase in benefits takes affect in December each year; during years where there was high inflation this increase can be significant, but if inflation is not high, the increase can be very low.
Although it is never a good idea to rely exclusively on Social Security benefits to meet your living expenses after you retire, it is nice to know that those benefits are available to you. It is also comforting to know that these benefits will increase to cover the increased amount it costs you to meet your living expenses.