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For Your Life Stefon Walters November 25, 2024

What Is a Social Security COLA and How Can It Affect Your Retirement Plan in 2025?

It seems like not too long ago, you could walk into a grocery store with $100 and almost fill up a cart. Nowadays, if you walk into a grocery store with $100, you might be able to fill up a basket.

For the most part, prices have consistently risen over time, and it's not limited to just groceries. You could fill up a notebook listing items that are more expensive than in previous years. And it all comes down to one thing -- inflation.

Inflation affects everyone, but it's especially noticeable for those with fixed-income sources like Social Security. The good (but could-be-better) news, though, is that Social Security has a system in place to try to put a bandage on this issue.

How Social Security deals with rising prices

To help offset rising prices, Social Security provides an annual cost-of-living adjustment (COLA) that kicks in at the beginning of each year. The Social Security Administration uses the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) -- a monthly metric that tracks inflation on expenses common to wage earners -- to determine the COLA for the upcoming year.

It takes the CPI-W data from July, August, and September (Q3), calculates the average, and then compares it to the previous year's number. The percentage increase in CPI-W is how much the COLA will be.

For example, the CPI-W average from Q3 2023 was 301.236. In Q3 2024, the average was 308.729. This roughly 2.49% increase is how we ended up with the 2.5% COLA for 2025.

In the event that the CPI-W data from one year is the same or lower than the previous year, there will be no COLA, and monthly benefits will remain the same. There won't be a situation where Social Security reduces monthly benefits because of a drop in the CPI-W.

How the new COLA can affect your retirement plan in 2025

The most direct and obvious effect of the new COLA is the increase in monthly benefits. If your monthly Social Security benefit is $1,000 this year, it will be $1,025 starting in January 2025. If it's $2,000 now, it'll be $2,050.

That part is straightforward. The less straightforward aspect is that Social Security recipients should plan for less purchasing power next year.

Ideally, the annual COLA would cancel out inflation completely, but that's unfortunately not the case. According to senior advocacy group The Senior Citizens League, Social Security recipients' purchasing power has decreased by 20% since 2010. This means $100 in 2010 would only get you around $80 worth of stuff today.

A 2.5% increase beats no increase, but it likely won't keep up with the rising costs retirees face. The CPI-W is a fairly broad metric that doesn't necessarily focus on expenses typically more relevant to retirees, such as medical care and health services. PwC's Health Research Institute projects medical costs will rise by around 7.5% for people with individual insurance. That's far less than the 2025 COLA.

How the 2025 COLA compares to previous years

The 2.5% COLA is admittedly modest, but history shows it could be worse. Below are the past 10 COLAs before 2025:

Year COLA
2024 3.2%
2023 8.7%
2022 5.9%
2021 1.3%
2020 1.6%
2019 2.8%
2018 2%
2017 0.3%
2016 0%
2015 1.7%

Source: Social Security Administration. Chart by author.

For some perspective, the average COLA since 1975 is 3.75%. The highest-ever COLA was 14.3% in 1980. In 2010, 2011, and 2016, there were no COLAs.

While retirees undoubtedly appreciate a high COLA because it means more money, it also means inflation is high, so the grass isn't always greener. Take 2023, for example, when the COLA was 8.7%. A huge boost is nice, but inflation in 2022 was also the highest it had been in four decades. Take your pick.

Many things are out of your control, including inflation. The best thing you can do is keep your retirement finances fluid and be willing to adjust certain spending to protect your long-term financial security.

 

This article was written by Stefon Walters from The Motley Fool and was legally licensed through the DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.

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