As the new year approaches, millions of retirees who rely on Social Security are anxiously waiting for the cost-of-living adjustment (COLA), which will determine the percentage increase in their benefits. After several years of significant increases driven by inflation, predictions for 2025 point to a much smaller adjustment.
According to recent estimates, the increase may be around 2.5%, the lowest rate since 2021. This figure is based on current inflation trends and, although not yet final, is already causing concern among retirees.
Why is a 2.5% increase expected for retirees?
In recent years, Social Security benefits have seen substantial adjustments. For instance, in 2023, there was an 8.7% increase, the largest in over 40 years, triggered by the sharp rise in inflation following the pandemic. While the 2024 increase was more moderate at 3.2%, it still reflected the lingering effects of inflation.
The main reason for the projected 2.5% increase in 2025 is the recent decline in inflation data. The COLA is calculated using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter, a subset of the broader consumer price index. This index tracks changes in the prices paid by workers and shows that although inflation remains, it has slowed down compared to the extreme levels of the past few years.
What does this mean for retirees?
A 2.5% increase may seem small compared to recent adjustments, but it’s important to put it in perspective. The 8.7% increase in 2023 was an exceptional response to a unique economic situation. In previous years, the adjustments were more restrained. For instance, in 2021, the increase was only 1.3%. If the 2.5% estimate holds for 2025, it would align more closely with the historical average from recent years.
For retirees living on fixed incomes, even a small increase can make a significant difference. Many depend heavily on their Social Security benefits to cover basic living expenses, and a smaller increase in 2025 could make it harder to keep up with the ever-changing prices of essential goods and services.
The impact of inflation on retirees’ incomes
Although inflation has slowed in recent months, it remains a key factor affecting the financial well-being of retirees. As prices rise, the purchasing power of seniors relying on Social Security decreases. This is why the COLA is so important—it’s designed to help benefits keep pace with inflation.
In years of high inflation, such as 2023, a large adjustment can provide temporary relief. However, many retirees feel that, despite these adjustments, their incomes don’t increase enough to fully offset the rising cost of living. Expenses like healthcare, which often increase faster than other costs, continue to be a significant burden.
Taxes and Medicare premiums: what reduces the net increase
One overlooked factor is that the COLA doesn’t always translate into a substantial net increase for retirees. Several factors, including taxes on benefits and Medicare premiums, can reduce the real impact of these adjustments.
Up to 85% of Social Security benefits may be subject to federal taxes, depending on the retiree’s combined income. This income includes half of the Social Security benefits, adjusted gross income, and any non-taxable interest. The higher the combined income, the greater the portion of benefits subject to taxes.
In addition, Medicare Part B premiums, which cover medical services, also tend to increase each year, further cutting into the net benefit increase.
This means that even if retirees see a 2.5% COLA adjustment in their Social Security payments, the actual impact on their take-home income could be smaller once these additional costs are factored in.
Trump’s proposal to eliminate Social Security benefit taxes
One issue that has sparked debate in recent months is former President Donald Trump’s proposal to eliminate taxes on Social Security benefits. During his campaign, Trump has reaffirmed his commitment to easing the financial burden on retirees by eliminating these taxes, which could provide significant relief to many beneficiaries.
Currently, beneficiaries whose combined incomes range between $25,000 and $34,000 (for single filers) or between $32,000 and $44,000 (for joint filers) may pay taxes on up to 50% of their benefits. If their incomes exceed these thresholds, up to 85% of their benefits may be taxed.
However, Trump’s proposal is not without criticism. According to the Committee for a Responsible Federal Budget, eliminating these taxes could create deficits in the Social Security and Medicare trust funds, with an estimated impact of between $1.6 and $1.8 trillion by 2035.
What can we expect from the official announcement in October?
The Social Security Administration will officially announce the COLA in October 2024, after gathering complete inflation data for the third quarter. While current estimates point to a 2.5% increase, this figure could still change depending on September’s inflation numbers.
There is a possibility that the adjustment could be slightly higher or lower, but most experts agree that we won’t see a spike like the ones in the past two years. This reflects the slower pace of inflation, although for retirees who are already feeling financial pressure, any reduction in the adjustment may raise concerns.