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One of the most important parts of Social Security is the annual cost-of-living adjustment, or COLA. With the price for nearly everything rising over the last few years, the annual raises built into the government program can be a major lifeline for many retirees.
Every October, the Social Security Administration (SSA) announces how much more seniors will receive from the government program the next year due to inflation. The COLA for 2025 will be 2.5%, which is a big step down from the increases received for the last three years.
Many seniors might be disappointed in the relatively small COLA, but it’s worth taking a broader perspective and comparing the 2025 raise to those from the last 25 years.
Here’s how the latest cost-of-living adjustment stacks up.
Image source: Getty Images.
Where does 2025 rank among 21st century COLAs?
When you look at the history of Social Security COLAs since the turn of the century, the 2025 COLA is remarkably average. It ranks as the 12th highest COLA since 2001 and sits just under the 2.58% average of the past 25 years. The table below, ranked from largest to smallest COLA, shows exactly how it stacks up.
| Rank | Year | COLA |
|---|---|---|
| 1 | 2023 | 8.7% |
| 2 | 2022 | 5.9% |
| 3 | 2009 | 5.8% |
| 4 | 2006 | 4.1% |
| 5 | 2012 | 3.6% |
| 6 | 2001 | 3.5% |
| 7 | 2007 | 3.3% |
| 8 | 2024 | 3.2% |
| 9 | 2019 | 2.8% |
| 10 | 2005 | 2.7% |
| 11 | 2002 | 2.6% |
| 12 | 2025 | 2.5% |
| 13 | 2008 | 2.3% |
| 14 | 2004 | 2.1% |
| 15 | 2018 | 2.0% |
| 16 | 2013 | 1.7% |
| 17 | 2015 | 1.7% |
| 18 | 2020 | 1.6% |
| 19 | 2014 | 1.5% |
| 20 | 2003 | 1.4% |
| 21 | 2021 | 1.3% |
| 22 | 2017 | 0.3% |
| 23 | 2010 | 0% |
| 24 | 2011 | 0% |
| 25 | 2016 | 0% |
Data source: Social Security Administration.
The big challenge for retirees is that they’re still reeling from the high inflation experienced in 2021 and 2022, which was reflected in the COLAs for the following years. Those years top the list, and 2024’s 3.2% was high enough to make it into the top third.
Seniors might feel costs are higher than reflected in the recent COLAs due to the way the adjustment is calculated. The SSA uses a subset of the CPI-U called CPI-W, which measures the cost of a basket of goods and services typical for an urban wage earner or clerical worker.
Many argue the SSA should use an inflation measure called CPI-E, which tracks the typical spending of someone 62 or older. If CPI-E was used instead, retirees would receive a 3.0% COLA in 2025 (not to mention a higher 4.0% COLA in 2024 as well). But the overall change in benefits since the end of 2020 would actually be slightly lower due to lower theoretical increases in 2022 and 2023. The existing method actually helped seniors amid record-high inflation.
The hidden benefit of an average COLA
While next year’s COLA will come in lower than the previous three years, there are still some benefits to an average COLA that retirees should consider.
The buying power of your benefit check should stay relatively stable over time as the COLA is merely designed to keep up with inflation. But any savings you have for retirement outside of Social Security probably aren’t as closely tied to inflation. As such, the purchasing power of your retirement portfolio is usually higher in a low-inflation environment, all else being equal.
Considering the fact the S&P 500 increased 24% in 2023 and is up another 22% so far this year, the real value of your retirement savings is significantly higher today than just a couple of years ago. But low and steady inflation is possibly even more important in years when the market declines. If you use a fixed withdrawal rate like the 4% rule, low inflation will put much less strain on your portfolio in down years. That’s because you won’t have to adjust your withdrawal upward as much due to inflation.
Lastly, low inflation means you won’t need as much income in retirement. That can have a significant impact on how much you pay in taxes during retirement since Social Security taxation thresholds do not get an inflation adjustment. As a result, you could end up keeping more for yourself or for your heirs.
If you look at the bigger picture, 2025’s COLA has a lot of upside to it.
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Adam Levy has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
