Slow and steady inflation is ultimately good for Social Security recipients.
Social Security is an increasingly important part of many seniors’ retirement budgets. In an annual Gallup poll, 60% said Social Security is a major source of income, the highest level in more than a decade. Another 28% said it is at least a minor source of income in retirement.
Because many seniors rely on Social Security to get by, the annual cost of living adjustment (COLA) is of great importance to them. Beneficiaries receive an increase in their monthly checks each year based on the average annual inflation rate in July, August and September. We’re about a month away from getting the first set of data that will be used to calculate retirees’ COLA, but analysts are already making their best guesses about where it might end up.
Following the June Consumer Price Index (CPI), The Senior Citizens League updated its forecast. Despite lower-than-expected inflation last month, the group raised its expectations to a COLA of 2.63%, up from 2.57% last month.
Seniors may be disappointed with a forecast that is far below the 3.2% COLA they received this year. That’s especially true as Social Security becomes an increasingly important part of their budgets, while inflation has eaten away at its purchasing power. But The Senior Citizens League’s forecast is actually great news for retirees.
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The biggest problem for seniors who depend on social security
The annual cost of living adjustment can be a double-edged sword for retirees. Because the COLA is based on inflation, it only goes up significantly when inflation increases significantly. And high inflation rates have been extremely damaging to seniors’ retirement budgets.
The average retiree who began collecting benefits in 2000 has seen his cost of living rise much faster than his Social Security benefits. The Senior Citizens League estimates that benefits have effectively lost 36% of their purchasing power. High inflation rates in 2021 and 2022 have led to large COLAs, but also to larger declines in how much seniors could afford on their Social Security income alone.
But not all inflation is bad for seniors. A healthy economy experiences a slow and steady increase in the money supply, resulting in modest levels of inflation. The Federal Reserve, which indirectly controls the money supply, currently aims to reduce inflation to 2% while maintaining full employment.
If you look at the recent history of Social Security COLAs and their effect on retirees’ purchasing power, a lower COLA is generally a good thing for seniors. Since 2010, Social Security’s purchasing power has improved in most cases when the COLA is less than 3%. Purchasing power has improved by a cumulative 13% over the years when the COLA was less than 2% during that period.
The expectation that the COLA will only be 2.63% is therefore good news for retirees.
Many retirees are unable to keep their full COLA
Another problem with high cost-of-living adjustments is that they don’t take into account taxes on Social Security income. A larger Social Security check will often result in a higher tax bill.
The way the government taxes Social Security is based on a metric called combined income. Combined income equals half of your Social Security income, plus your adjusted gross income, plus untaxed interest income. So, all other things being equal, an increase in your Social Security income results in an increase in your combined income, and more of your benefits may become taxable as a result.
Below you can see how much of your Social Security income is taxable, based on your combined income and filing status.
| Taxable percentage of the benefits | Combined income (single person) | Combined income (joint filer) |
|---|---|---|
| 0% | Less than $25,000 | Less than $32,000 |
| Up to 50% | $25,000 to $34,000 | $32,000 to $44,000 |
| Up to 85% | More than $34,000 | More than $44,000 |
Data source: Social Security Administration.
If those thresholds seem low, that’s because they haven’t been updated in more than 30 years. There’s no inflation adjustment built into the system, so every year more and more retirees see a larger share of their benefits taxed by the federal government as the COLA increases their combined income. Many states, however, exempt Social Security income from taxes.
A lower COLA means seniors keep more of their benefits.
How big will the 2025 COLA be?
Recent CPI numbers for May and June are better than expected. If inflation remains flat in the third quarter, the COLA would be just 2.3%. More likely, we will see inflation of 0.1% to 0.2% per month, which would result in a COLA between 2.5% and 2.7%, in line with The Senior Citizens League’s forecast.
Inflation would need to average close to half a percentage point per month over the next three months to reach the same 3.2% COLA that was announced last October. That seems highly unlikely without major disruption.
We’re already halfway through July. The COLA picture for 2025 is starting to come together. The number will be determined in a few months, and it will likely be less than 3%. While that may be a decline from years past, retirees should be happy about a smaller COLA and shrinking inflation. It means they’ll likely see an increase in the purchasing power of their Social Security checks next year.