There’s always a tremendous amount of speculation about Social Security’s annual cost of living (COLA) increase. In fact, the first soothsayers stir the pot as early as February or March each year. Yet the COLA is only announced after inflation rates are known for the third quarter. Right on time, the Social Security Administration released the 2025 Social Security COLA on October 10th.
Those receiving Social Security retirement benefits learned they will get a 2.5% bump starting with their deposits in January.
Is the 2025 Social Security COLA sufficient?
Unbeknownst to most folks, the COLA calculation is embedded in the Social Security law. But only since the 1972 Amendments.
Before the 1970s, annual increases were not at all guaranteed. Some years Congress would hear complaints from constituents. Their Social Security payments were not keeping pace with the cost of living. Then Congress would make a sweeping adjustment.
It was random, inconsistent, and frustrating for the oldest Americans. While the increases were welcome, they didn’t help at the right time. There were no increases for the first 10 years of payments—from 1940 to 1949. Then, beneficiaries got a 77% increase in 1950!
Here is the rest of the inflation adjustment history:
Keep in mind, the 1940s saw high inflation rates due to WWII. And the initial Social Security payments were lower relative to income as the program was just getting a start.
The 2025 Social Security COLA sure pales in comparison to a 77% increase. But it is sufficient based on the spirit and application of the law. And the current increases in overall prices for goods and services.
What’s behind the COLA calculation?
By the early 1970s, Congress decided it was time to put in a more formal, dependable increase in benefits. According to the published history of Social Security,
“In 1972 legislation the law was changed to provide, beginning in 1975, for automatic annual cost-of-living allowances (i.e., COLAs) based on the annual increase in consumer prices. No longer do beneficiaries have to await a special act of Congress to receive a benefit increase and no longer does inflation drain value from Social Security benefits.”
Then President Richard Nixon signed the 1972 Amendments into law. Turns out, it was a good provision to include a standardized COLA. We see how awaiting an act of Congress can bollocks up the works. Congress can’t even keep the government funded every year!
Today, the controversy is over which consumer price index to use to calculate the COLA. The law specifically defines how the COLA calculation is to be done:
- Calculate the increase in costs from Q3 of the prior year vs. Q3 of the current year.
- Use the CPI-W (Consumer Price Index for Urban Wage Earners and Clerical Workers) as the base index to calculate the increase.
Is the CPI-W the right index?
Well, that is a question mulled around by the academic community. It’s important to understand that while crafting the law, Congress needed to lock in a consistent calculation. They selected a readily available, reliable, and repeatable benchmark as the base for the calculation. In the 1970s, the best alternative was the Bureau of Labor Statistics’ CPI-W.
We know it’s not the perfect fit. Older Americans do spend differently from younger folks who are gainfully employed. There is a newer index that might be a favorable alternative. That’s the CPI-E (E=Elderly).
The CPI-E does indeed track spending by those 62 and older. But, as with every index, the devil is in the composition details. We find the CPI-E does not represent all Social Security beneficiaries. It leaves out tens of millions of those receiving benefits, including:
- 6 million surviving spouses, including young mothers and their children.
- 10 million disabled folks who are not yet 62.
- And it excludes all those who are 62 and older but not yet retired or collecting benefits.
So, neither index is “perfect.” And no index will be perfect. Furthermore, some years the CPI-W yields a higher COLA and other years it’s the CPI-E.
The real benefit is consistency
Because there are pros and cons to each option, the important point of the calculation is having a consistent benchmark. Look back at the 1950s and 1960s. What a rollercoaster. There was nothing retirees could rely on. And they were stuck with the agenda of the sitting Congress every year.
But it is important to recognize the issue with Social Security’s COLA. And that is the annual increases are seen by many (or most?) as too small to meet real retirees’ income needs. Especially in times like we just went through with 40-year high inflation rates. It’s more difficult to pay for groceries, gas and especially healthcare expenses.
Retirees must focus on cash flow in retirement. That’s the key to success. But it can be really tough to get right.
The 2025 Social Security COLA will certainly help retirees. But an increase of $49 (average increase) to $196 (highest benefits) per month won’t go too far. Especially after reducing monthly payments for Medicare Part B premiums.
Retirees need more than one leg to their retirement income stool
Social Security was never intended to be a retiree’s only source of income. But let’s acknowledge we don’t do much to help younger workers understand that fact. Especially those at lower income levels. It is increasingly difficult to meet the basic living expenses of today. And to save sufficiently for retirement.
Depending where you are relative to retirement, you have a different problem to solve:
- Younger folks should learn a lot more about saving and investing for retirement.
- Those in their 50s should probably plan to work longer than they might be thinking.
- Retirees who are falling short of cash flow needs could consider some part-time work, if possible. Or ways to downsize or cut back.
Everyone needs to do the math for themselves. Work on projecting your spending over the next ten years adjusting for inflation. It’s surprising to see how fast expenses grow.
No one wants to cut back or compromise on an ideal retirement. But the reality is we need a three-legged stool for retirement. And if it’s not in the cards, it’s time to get really creative.
The 2025 Social Security COLA does help
Just not as much as retirees were hoping for. But an increase of 2.5% in the 2025 Social Security COLA reflects good news. Our overall costs are not increasing as high as they had been a few years ago. And that is an important point to focus on.
Also consider the higher interest rates for less risky investments held in cash, CDs, and many bonds. These investments should be generating a higher return than in the low-rate environment of a few years back.
And retirees can work with their financial advisor or financial institution to invest smartly in the equity market. Despite the ups and downs of investments, there are lots of reasons to be well-diversified.
Creating an income in retirement takes a lot of time, skill, and discipline. It’s not like just getting a paycheck from an employer. Every year retirees can count on an increase in their Social Security retirement benefits. Unless costs drop year over year. Take the time to plan well and readjust along the way.
Other helpful Social Security blog posts and a link to my popular book:
Social Security COLA for 2019: Sort of Like a Soft Drink
Social Security is NOT Going Bankrupt (Again)
Ready to Claim Social Security? (includes check lists)
What’s the Deal with Social Security for Women (it’s also for men!)
