benzinga.com
fool.com
theblock.co
One of Social Security’s most anticipated days just passed: The announcement of next year’s cost-of-living adjustment (COLA). If you’re wondering why retirees tend to circle the COLA announcement date on their calendars, look no further than the prices of everyday items.
People don’t usually start cheering when they hear the word “inflation,” but it’s a necessary evil for a healthy, growing economy and much better than the alternative, deflation. That said, inflation has real effects on everyday people because it decreases their purchasing power.
Inflation is particularly noticeable for people on fixed incomes, like many who receive Social Security. To help offset this, Social Security applies a COLA. For 2025, the COLA will be 2.5%, and while I’m sure retirees appreciate any increase in benefits, many aren’t jumping for joy at the amount.
Image source: Getty Images.
How Social Security determines the annual COLA
The annual COLA is determined using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). It’s a monthly metric that tracks the changes in prices of common goods and services purchased by people who earn most of their money from office or hourly jobs in urban areas. That’s about 30% of the U.S. population. Common items included in the measurement are groceries, transportation, housing, clothing, and typical household items.
Social Security averages the CPI-W numbers from the third quarter (July, August, and September), compares the average to the previous year’s number, and uses the difference to set the COLA. For example, if the third quarter’s CPI-W is 5% higher than the previous year’s CPI-W number, the COLA will be set at 5%.
Here are the third-quarter CPI-W numbers and the following year’s COLA:
| Year | Average Third-Quarter CPI-W | COLA | Effective Date |
|---|---|---|---|
| 2024 | 308.729 | 2.5% | January 2025 |
| 2023 | 301.236 | 3.2% | January 2024 |
| 2022 | 291.901 | 8.7% | January 2023 |
| 2021 | 268.421 | 5.9% | January 2022 |
| 2020 | 253.412 | 1.3% | January 2021 |
Data source: Social Security Administration.
The increase from 301.236 to 308.729 is roughly 2.49%, which is how we end up with the 2.5% COLA for 2025.
If this year’s number had been lower than last year’s, monthly benefits would’ve remained the same. Social Security never decreases monthly benefits because of a drop in CPI-W numbers.
Why this year’s COLA is a double-edged sword
I consider the COLA a double-edged sword because, on one hand, an increase is better than nothing. There have been three years where there wasn’t a COLA, so having something is a positive. On the other hand, many retirees would agree that the modest 2.5% COLA won’t quite cancel out the rising prices they are experiencing.
According to The Senior Citizens League (a senior advocacy group), retirees’ purchasing power has declined by 20% since 2010. That means $1,000 back then is worth roughly $800 today. Needless to say, that’s not ideal.
One expense in particular that I like to focus on is medical costs, because healthcare is typically one of the largest expenses that seniors and retirees face. The following table shows medical cost increases for people with individual insurance compared to that year’s COLA.
| Year | Medical Cost Increase | Social Security COLA |
|---|---|---|
| 2025 | 7.5% (estimate) | 2.5% |
| 2024 | 7% | 3.2% |
| 2023 | 6.5% | 8.7% |
| 2022 | 5.5% | 5.9% |
| 2021 | 7% | 1.3% |
| 2020 | 6% | 1.6% |
Data source: PwC’s Health Research Institute and Social Security Administration.
Medical costs are just one example, but other expenses convey the same point. A COLA is good, but it’s often not enough for a 1:1 canceling out of inflation, which should be the ultimate goal if it’s adjusting to the rising cost of living in many areas.
Whether Social Security eventually changes its method for determining the COLA remains to be seen, but in the meantime, recipients can begin planning their 2025 finances by incorporating the incoming 2.5% 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.
