For most people the Social Security cost of living adjustment is a mystery. The most important thing is will there be an increase. Following is a somewhat simple explanation of the calculation mostly copied from the Social Security website.
What is a COLA?
Legislation enacted in 1973 provides for cost-of-living adjustments, or COLAs. With COLAs, Social Security and Supplemental Security Income (SSI) benefits keep pace with inflation.
How is a COLA calculated?
The Social Security Act specifies a formula for determining each COLA. According to the formula, COLAs are based on increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). CPI-Ws are calculated on a monthly basis by the Bureau of Labor Statistics.
A COLA effective for December of the current year is equal to the percentage increase (if any) in the average CPI-W for the third quarter of the current year over the average for the third quarter of the last year in which a COLA became effective. If there is an increase, it must be rounded to the nearest tenth of one percent. If there is no increase, or if the rounded increase is zero, there is no COLA.
The last year in which a COLA became effective was 2008. Therefore the law requires that we use the average CPI-W for the third quarter of 2008 as the base from which we measure the increase (if any) in the average CPI-W. The base average is 215.495.
The average CPI-W for the third quarter of 2010 was 214.136. Therefore, because there was no increase in the CPI-W from the third quarter of 2008 through the third quarter of 2010, there was no COLA for December 2010.
So what about 2012, will there be a COLA? We are still using the average for the third quarter of 2008 as the base.
In May 2011 the index was 222.954. If we assume the CPI-W stays at that level for July, August and September we have an average of 222.954 versus 2008 third quarter average 215.495 for a difference of 7.459 or a percent increase of 3.461 which could mean a Social Security COLA increase of 3.5%.