Retirees reliant on Social Security may face a lower cost-of-living adjustment (COLA) in 2025 as inflation moderates, according to recent estimates. Mary Johnson, an independent Social Security and Medicare policy analyst, projects that the COLA for next year could be around 3%. This figure is slightly below the 3.2% increase that beneficiaries received in January and significantly lower than the record 8.7% adjustment seen in 2023.
The Social Security Administration (SSA) calculates COLA based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This measure compares the third quarter CPI-W data of the current year to that of the previous year. If there is an increase, it determines the COLA for the upcoming year. Given the early stage of 2024, this estimate may still change as new data becomes available.
The most recent CPI-W data highlights why the expected COLA for 2025 might be lower. Prices for certain categories, including fuel oil, airline fares, and gasoline, have seen significant declines compared to two years ago. Fuel oil prices, for example, dropped by 35.3%, airline fares by 19.4%, and gasoline by 17.7%.
Despite these declines, many retirees continue to struggle with inflation, making adjustments such as cutting back on savings or dipping into assets. Laura Quinby, a senior research economist at the Center for Retirement Research at Boston College, emphasized the long-term impact of these adjustments: "They take a big hit to their future wealth by doing that."
The effects of Social Security's COLA vary for individuals based on their expenses and location. Some experts argue that the CPI-W is not a perfect measure for retiree spending. For instance, while the CPI-W assumes that older adults spend about 66% of their income on housing, food, and medical costs, the actual figure is closer to 75%. This discrepancy suggests that the COLA based on CPI-W may undercount real senior inflation by more than 10%, according to Johnson.
The Senior Citizens League recently updated its COLA forecast following the latest consumer price index (CPI) reading for May. They now expect a 2.57% increase in Social Security checks next year, down from a previous estimate of 2.66%. This is well below the 3.20% COLA seniors received this year. However, a lower COLA could be a positive surprise for retirees.
A higher-than-average COLA indicates higher-than-average inflation, which erodes the purchasing power of Social Security benefits. The average retiree who started receiving benefits in 2000 has seen their cost of living climb significantly faster than their monthly checks, losing about 36% of their purchasing power, according to The Senior Citizens League. Low and stable inflation, on the other hand, has historically improved Social Security's buying power.
Another factor to consider is the taxation of Social Security benefits. Social Security income is taxed based on combined income, which includes half of Social Security benefits plus adjusted gross income and any non-taxable interest income. As benefits increase, so does combined income, potentially making more of the benefits taxable.
The thresholds for taxable Social Security benefits have not been updated in over 30 years and do not adjust for inflation, resulting in higher tax bills for many seniors. A lower COLA can help retirees keep more of their Social Security benefits instead of paying taxes.
The Federal Open Market Committee (FOMC) plays a crucial role in determining interest-rate policies to support full employment and stable inflation. The Fed's current goal is to reduce inflation to 2%. Following the latest FOMC meeting, Fed Chairman Jerome Powell indicated that there might only be one interest-rate cut before the end of the year, suggesting a cautious approach to inflation control.
While the May CPI reading was positive, showing a year-over-year increase of 3.3%, there is still time before the end of the third quarter for inflation to change. The Senior Citizens League's forecast assumes minimal changes in pricing from May through September, which might be optimistic.
Ultimately, the 2025 COLA is likely to be below 3%, which, despite being lower than last year's adjustment, could still be beneficial for retirees. Lower inflation would mean a higher purchasing power for Social Security checks, providing some financial relief to seniors who depend on these benefits.
