For the overwhelming majority of retirees, Social Security represents more than just a monthly check. It’s a vital source of income that lays a financial foundation for aging Americans who can no longer provide for themselves.

For the last 23 years, Gallup has been conducting annual surveys to determine how reliant retirees are on the income they receive from Social Security. Since 2002, between 80% and 90% of respondents, including 88% in April 2024, have noted that their Social Security payout is, to some degree, needed to make ends meet.

These polling results show why the cost-of-living adjustment (COLA) reveal by the Social Security Administration (SSA) is the most-anticipated announcement for beneficiaries year after year.

In the early morning hours of Oct. 10, the SSA lifted the hood on the 2025 COLA, which offers something of a good news/bad news scenario for Social Security recipients in the upcoming year.

Image source: Getty Images.

What is Social Security’s COLA, and how does the SSA calculate it?

Social Security’s “COLA,” which you’ve probably been hearing about endlessly for weeks, is the tool the SSA has to adjust Social Security benefits for the effects of inflation.

For example, let’s say the cost to buy a broad basket of goods and services rises by 3%. If Social Security benefits don’t increase, retirees would lose purchasing power to inflation (rising prices) over time. COLA is simply the “raise” passed along most years that’s designed to keep beneficiaries from losing buying power.

For the first four decades of Social Security’s existence — when it was signed into law in 1935 through 1974 — there was no rhyme or reason to adjusting benefits. Following the first mailed retired-worker check in January 1940, it took a little over a decade before the first COLA was passed by a special session of Congress.

Starting in 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) was used to measure price changes. This was a big leap forward for America’s top retirement program because it allowed for annual cost-of-living adjustments.

Although the CPI-W is reported monthly, just the trailing-12-month readings ending in the third quarter (July, August, and September) are factored into Social Security’s COLA calculation. If the average Q3 CPI-W reading in the current year is higher than the same period of the previous year, Social Security checks are set to climb.

The amount of the raise passed along to beneficiaries equates to the year-over-year percentage difference in average Q3 CPI-W readings, rounded to the nearest tenth of a percent.

A sizable increase in the U.S. money supply during the COVID-19 pandemic led to four consecutive years of above-average COLAs. US Inflation Rate data by YCharts.

Here’s what Social Security’s 2025 COLA means for your monthly benefit

Throughout the 2010s, beneficiaries had little to look forward to. This decade featured the only three years over the last half-century with deflation, which resulted in no COLA being passed along (2010, 2011, and 2016), as well as the smallest positive COLA on record (0.3% in 2017).

However, the tide has changed in a meaningful way in recent years. The COVID-19 pandemic led to the largest year-over-year increase in U.S. money supply, which in turn sent the prevailing rate of inflation soaring to a four-decade high. Following a decade of mostly anemic COLAs, beneficiaries enjoyed raises of 5.9% in 2022, 8.7% in 2023, and 3.2% in 2024. The 8.7% cost-of-living adjustment marked the largest percentage increase since 1982.

On Oct. 10, following the release of the final puzzle piece needed to calculate Social Security’s 2025 COLA (the September inflation report), the SSA announced that beneficiaries would see their monthly checks climb by 2.5% in the upcoming year.

Despite being the smallest-upward adjustment in benefits over the last four years, it still represents an above-average boost. The average cost-of-living adjustment since 2010 has been a more modest 2.3%.

But it’s one thing to talk about percentages and an entirely different matter when digging into what the 2025 COLA actually means for your benefit.

The lion’s share of Social Security recipients are retired workers. The SSA estimates that the average retired-worker beneficiary will be taking home around $1,927 per month by the end of 2024. But when the 2.5% COLA kicks in for the new year, the typical retired worker will see a $49 per-month lift in their payout to $1,976, or roughly $588 extra per year.

Workers with disabilities and survivor beneficiaries will receive a 2.5% increase to their monthly checks, as well. For the average worker with disabilities, their Social Security benefit is projected to rise by $38 per month, from $1,542 to end 2024 to $1,580 to begin the new year.

Meanwhile, the average Social Security check for survivors of deceased workers should also climb by $38 per month, from $1,513 to close out 2024 to an estimated $1,551 in 2025.

Image source: Getty Images.

Bad news: Important costs are going to offset some or all of your 2025 COLA

But as noted earlier, Social Security’s 2025 COLA is a mixed bag. Although it does provide a fourth-consecutive year with an above-average raise, when compared to the previous 15 years of COLAs, a majority of retirees aren’t going to enjoy the full effect of next year’s adjustment.

One of the biggest problems for retirees is how this fourth-consecutive year of an above-average raise was achieved. Even though the prevailing rate of inflation has been declining of late, the costs that matter most to seniors have been sticky.

Compared to the typical working-age American, seniors spend a higher percentage of their monthly budget on shelter expenses and medical care services. Based on the September inflation report, the trailing-12-month price increase for shelter (the largest-weighted component of the CPI-W) and medical care services, per the Consumer Price Index for All Urban Consumers (CPI-U), which is a similar inflationary index to the CPI-W, was 4.9% and 3.6%, respectively. As long as these critical costs for retirees are climbing at a rate faster than the 2025 COLA, it sets most retired workers up to lose purchasing power.

Not surprisingly, a study published in July by nonpartisan senior advocacy group The Senior Citizens League found that the buying power of a Social Security dollar has declined by 20% since 2010 for seniors.

Additionally, Medicare’s Part B premium is expected to rise by 5.9% to $185 per month next year. Part B is the segment of Medicare responsible for outpatient services, and this premium is usually deducted from the monthly check of Social Security beneficiaries aged 65 and above (i.e., the age of eligibility to enroll in Medicare).

If this Part B premium estimate proves accurate, it would more than double the 2025 COLA and partially or completely offset the raise retired workers are set to receive in the new year.

Though a 2.5% cost-of-living adjustment is just two months away, it’s unlikely many beneficiaries will feel the full effect of this increase.

The $22,924 Social Security bonus most retirees completely overlook

If you’re like most Americans, you’re a few years (or more) behind on your retirement savings. But a handful of little-known “Social Security secrets” could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $22,924 more… each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we’re all after. Simply click here to discover how to learn more about these strategies.

View the “Social Security secrets” »

The Motley Fool has a disclosure policy.