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The 2025 Social Security Cost of Living Adjustment (COLA) is almost official and could bring a surprising benefit to many retirees

The 2025 Social Security Cost of Living Adjustment (COLA) is almost official and could bring a surprising benefit to many retirees

The Social Security Administration will announce the 2025 Social Security Cost of Living Adjustment (COLA) on October 10, and it could disappoint many retirees.

Over the past three years, seniors have become accustomed to outsized raises. The COLAs for 2022, 2023 and 2024 were 5.9%, 8.7% and 3.2%, respectively. As things stand today, pensioners should only expect an increase of 2.5% in 2025.

However, a lower COLA offers a surprising benefit for many retirees and could mean many seniors will be better off with a smaller monthly benefit check.

Two checks from the US Treasury.Two checks from the US Treasury.

Image source: Getty Images.

How the government calculates the Social Security COLA

The annual Social Security cost of living adjustment is designed to help Social Security benefits keep pace with inflation. The Social Security Administration uses a subset of the Consumer Price Index, known as CPI-W, which measures the cost of a basket of goods and services that correspond to the typical expenses of an urban wage earner or office worker.

Specifically, the SSA measures the increase in the CPI-W in the third quarter of the year compared to the previous year. This increase becomes the COLA for the following year. So the 2025 COLA will be official when the SSA receives the September CPI-W value on October 10th.

Many argue that the CPI-W is not representative of the spending of most seniors. That means the COLA doesn't keep pace with retirees' annual spending on goods and services. In fact, the Bureau of Labor Statistics created a new CPI subgroup called CPI-E that measures the cost of a shopping basket and tracks the spending habits of Americans age 62 and older. These are the households directly affected by the Social Security COLA.

Some have argued that switching the COLA to the CPI-E or another measure that better reflects retirees' true costs will help many retiree households maintain their standard of living. The Senior Citizens League says the average Social Security recipient who started receiving Social Security in 2010 has seen their purchasing power drop by 20% since receiving their first check.

But the fact that COLAs are based on a measure of inflation, even if it's arguably the wrong one, means that a smaller COLA could, surprisingly, be a good thing for many retirees.

The surprising benefit of a small Social Security COLA

Many retirees don't rely solely on Social Security to fund their retirement budget. They saved and invested in their IRAs, 401(k)s, and taxable brokerage accounts.

The average household with someone age 62 or older who saved and invested during their career had $200,000 invested in retirement and brokerage accounts at the end of 2022, according to the Federal Reserve's latest survey of consumer finances. Based on stock market returns since then, these holdings are likely to have increased significantly.

There is no cost of living adjustment for these investments. They are subject to the whims of the market. All other things being equal, these investment accounts have greater purchasing power when inflation is low. Meanwhile, Social Security's COLA is lower when inflation is low, but in theory it is intended to maintain purchasing power.

Retirees with significant retirement savings could be much better off with a lower COLA in 2025. You will actually have more purchasing power in the future if the COLA stays low.

Even if you rely heavily on Social Security, slow and steady inflation has historically had a better impact on the overall purchasing power of those monthly checks than higher inflation. The Senior Citizens League found that since 2010, Social Security's purchasing power increased in most years when the COLA was below 3%. Since the Fed continues to target 2% annual inflation, a 2.5% increase next year should still result in an increase in purchasing power.

So while many may be disappointed by the SSA's Oct. 10 announcement, seniors in 2025 should have an easier time affording things when they look at the bigger picture and their total retirement savings and income.

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The 2025 Social Security Cost of Living Adjustment (COLA) is almost official and could bring a surprising benefit to many retirees. It was originally published by The Motley Fool

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