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A cost of living adjustment (COLA) is an increase in your pay or benefits that can help offset the impact of rising costs for goods and services. In other words, your income increases to help you keep up with inflation so you can afford similar expenses. These adjustments can affect anyone receiving benefits or wages with COLAs, but they may be especially important for people with fixed incomes, such as some retirees and people with disabilities.
What Is the Purpose of a Cost of Living Adjustment?
Cost of living adjustments are intended to at least partially offset rising prices due to inflation.
For example, according to the USDA, the cost of food at home increased by about 5% in 2023. As a result, consumers needed $105 to buy the same food they bought for $100 in 2022, and a 5% COLA could help them make those purchases.
There are a few basic things to know about COLAs:
- Can help maintain a lifestyle: A COLA isn't intended to increase your purchasing power—how much you can buy with $1. It's supposed to help you maintain your lifestyle based on changing prices for goods and services.
- Raises aren't based on performance: An employer might offer an annual or one-time COLA to help you maintain your lifestyle, and these types of COLAs may be most common in the private sector and unionized workforces. However, a COLA raise shouldn't be framed as a raise because of your good work, and you could still try to negotiate a performance-based raise.
- Are most common with Social Security and public pension plans: Retirees who receive Social Security benefits or who worked for government agencies may receive automatic COLAs. The COLA for pension plans—a type of retirement plan—could be particularly important for retired government workers who might not pay into or receive Social Security benefits. Private employers' defined benefits plans are less likely to offer COLAs.
- Could depend on the cost of living in different areas: Some COLAs are based on local rather than national inflation rates. For example, military members may get a cost of living "allowance"—still called a COLA—based on where they're stationed. And some private employers may adjust salaries based on where an employee lives.
Although there are examples of employees who receive COLAs while working, they're most commonly associated with Social Security benefits and pension plans—a type of defined benefit retirement plan.
How Does the Cost of Living Adjustment Work?
Cost of living adjustment calculations can work differently depending on the program and who pays the benefits or wages.
How Social Security Cost of Living Adjustments Work
The Social Security COLA is perhaps the most widely discussed COLA because so many people receive Social Security benefits—nearly 68 million in 2024, or 90% of people who are 65 or older, according to the Social Security Administration.
The Social Security Act requires Social Security and Supplemental Security Income (SSI) benefits to make COLAs each year. Here's how they work:
- Based on changes in the CPI-W: The adjustment depends on the third-quarter averages of the consumer price index for urban wage earners and clerical workers (CPI-W) for the current year and the previous year that there was a COLA. The CPI-W focuses on the cost of specific goods and services that families in urban areas who make at least half their income from clerical or hourly wages purchase regularly buy.
- Starts the next year: Benefits increase in line with the CPI-W increase (rounded to the nearest 0.1%), and the amount is announced near the end of the year. The increase starts in January of the next year.
- Never decreases benefits: Social Security benefits will stay the same if there's deflation or no increase in the CPI-W.
Since 1975, the Social Security COLA has led to an increase in benefits every year except 2009, 2010 and 2015.
How Other Cost of Living Adjustments Could Work
The COLA for other types of benefits, pensions and wages may depend on different calculations and timelines.
For example, agencies and organizations might use the more general consumer price index (CPI or CPI-U), rather than the CPI-W, to determine COLA amounts. And some may use a local rather than national CPI.
The plans or agreements can also have different features that affect the COLA, such as:
- Automatic and ad hoc: The COLA may be automatic based on a predetermined rate or formula. There may alternatively or additionally be a one-time, or ad hoc, COLA.
- Simple or compound: Whether the COLA applies to a base rate, such as your original benefit amount when you retired, or if it compounds with previous COLAs.
- Inflation-based: Many COLAs are based on an inflation rate, but they can depend on different inflation rates and different amounts of the inflation rate.
- Performance-based: Pension plans often invest the money in the pension fund and may base COLAs on their investment returns.
- Caps and limitations: There may be a cap on the COLA regardless of the inflation rate, or the COLA may only apply to a portion of your benefits. You also might not receive COLAs until the end of a waiting period or when you reach a certain age.
- Self-funded: You might have the option of receiving a lower benefit amount in exchange for an automatic annual COLA.
How Much Is the COLA for 2025?
The COLA for Social Security benefits in 2025 is 2.5%, and the increase will take effect starting January 2025. Here's what COLAs have looked like for the last several years.
| Social Security COLAs, 2020-2025 | |
|---|---|
| Year | Social Security COLA |
| 2020 | 1.6% |
| 2021 | 1.3% |
| 2022 | 5.9% |
| 2023 | 8.7% |
| 2024 | 3.2% |
| 2025 | 2.5% |
The COLA is a slightly lower increase than in previous years, reflecting that the inflation rate—which only measures the change in prices compared to the previous year—has decreased.
COLAs for other benefits may differ. For example, the COLA for federal employees who are part of the Federal Employees Retirement System (FERS) will receive a 2% COLA in 2025.
How to Calculate Your COLA Increase
You can calculate your COLA increase in dollar amounts by multiplying the COLA rate by your monthly benefits.
For example, the average Social Security benefit for a retired worker was $1,927 in 2024. The 2.5% increase means their benefits will rise by $48 ($1,927 x .025 = $48), and they'll now receive $1,975 each month.
The Bottom Line
A COLA can help people who receive Social Security or pension benefits keep up with inflation. Some employers also offer a COLA to employees to improve retention rates or because of guarantees in union contracts. But even if you receive a COLA, it might not cover all the rising costs that affect your household. Getting ahead financially could require you to find ways to increase your income, earn higher investment returns and cut your expenses.