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What is a cost-of-living adjustment?

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Quick Answer

A cost-of-living adjustment refers to adjustments made to financial compensation that account for increases in the general cost of living, explains Investopedia and InvestorWords. Administrators generally tie cost-of-living adjustments to the Consumer Price Index, which tracks inflation of prices and living costs in the United States.

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Full Answer

Social Security and Supplemental Security Income both use built in cost-of-living adjustments to modify payments based on current levels of inflation, explains the Social Security Administration. Social Security and Supplemental Security Income modify their payments based on the Consumer Price Index for Urban Wage Earners and Clerical Workers from the third quarter of the last year to the third quarter of the current year. For instance, in 2015, Social Security and Supplemental Security Income benefits rose by 1.7 percent based on this cost-of-living adjustment formula.

Many salaried jobs and other contracts defining ongoing reimbursements included cost-of-living adjustment formulas to offset inflation, states Investopedia. These cost-of-living adjustments were especially popular during and after the 1970s when inflation was particularly high.

The U.S. Bureau of Labor Statistics determines the Consumer Price Index used for most cost-of-living adjustments, notes the Social Security Administration. Congress implemented cost-of-living adjustments to Social Security first in 1972 and made them automatic in 1975. Cost-of-living adjustments use the Consumer Price Index instead of the Producer Price Index to more closely match the real cost of living, explains InvestorWords.

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