What is the Social Security COLA and how can it affect my 2025 retirement plans?

If you’re currently retired and receiving Social Security or are still in the planning stages, you’ve probably heard of cost-of-living adjustments (COLAs).

COLAs are essentially annual “increases” designed to ensure benefits maintain their purchasing power over time. Because Social Security benefits are provided for life, they should be able to keep up with inflation for decades.

COLA may sound simple and straightforward, but the program faces several challenges that could impact retirement after 2025. Here’s everything you need to know about how to plan for retirement with COLA in mind.

Image source: Getty Images.

How is the Social Security COLA determined?

The actual calculations that determine the COLA are quite complex, but essentially the adjustment means that it reflects changes in inflation from year to year.

It is based on the Consumer Price Index for Urban Wage and White Collar Workers (CPI-W), published monthly by the U.S. Bureau of Labor Statistics. This index measures the average change in prices of specific goods and services.

The Social Security Administration uses three quarterly data from the CPI-W, averaging values ​​for July, August, and September. If the average is higher than the average for the same period in the previous year, the percentage difference becomes the COLA for the following year. Anything lower than this and there will be no COLA for the year.

Historically, COLAs tend to fall between 1% and 3% per year. But soaring inflation in recent years has led to record corrections. Because COLAs are directly tied to cost changes, higher inflation generally leads to higher increases.

Source: Social Security Administration. This is a table by author.

In 2024, the adjustment rate was 3.2%. For example, if you’re saving $2,000 a month in Social Security benefits, you’ll get an extra $64 a month starting in January of this year.

The Social Security Administration is scheduled to announce the 2025 COLA later this month, and the adjustments are scheduled to take effect in January of next year.

Potential Challenges Ahead

COLAs can be a lifeline for many retirees. This is especially true as costs continue to skyrocket and funds are tight for those living on fixed incomes. Every dollar counts, and this annual increase can go a long way.

But even though COLAs are designed to keep up with inflation, they are having trouble doing so. In fact, Social Security benefits are actively losing purchasing power over time. That means you won’t benefit as much as you did 10 or 20 years ago.

The purchasing power of benefits has fallen 20% since 2010, according to a 2024 report from the nonprofit The Senior Citizens League. Moreover, for Social Security benefits to remain the same value they were in 2010, the average beneficiary would need about $370 more per month.

The problem appears to be getting worse in recent years. The report said inflation rates have exceeded the COLA in four of the past five years. The only year in which COLA outpaced inflation was 2023, which saw the highest COLA in 40 years.

Some experts have urged the Social Security Administration to adjust how it calculates COLA by using CPI-E (which tracks changes in spending over age 62) instead of CPI-W, which measures spending patterns at working age. adult.

Setting a COLA based on CPI-E may result in a larger COLA, as older adults often allocate more of their budget to expenses such as housing and basic necessities. These costs have skyrocketed compared to many others in recent years. But because the Social Security program already faces cash problems related to its trust funds, it is unlikely that they would make changes that would make those problems worse.

How might this affect your retirement?

The loss of Social Security’s purchasing power will have the greatest impact on those who rely heavily on their retirement benefits. They now make up about 60% of retirees, according to a 2024 poll from Gallup.

If possible, the best thing you can do is find ways to reduce your dependence on Social Security. If you’re still working, this may involve saving more or finding another source of income. You can also cut costs to see if there are ways to increase your savings even further.

This isn’t possible for everyone, and many retirees are already struggling financially. But at least keeping yourself informed of the situation can be of great help. By making every adjustment you can to reduce your dependence on Social Security, you will be less affected by any problems the program may face.