Social Security is an essential lifeline for many retirees. About half of households with someone age 65 or older receive at least 50% of their income from the program, according to data collected by the Social Security Administration. Without Social Security, millions of seniors would be living in poverty.
Since many seniors are reliant on Social Security for their living expenses, the annual cost-of-living adjustment (COLA) is an important part of their benefits. Beneficiaries receive an increase in their monthly checks based on how much prices increase in the third quarter from year to year. While we haven't reached the third quarter for 2024 yet, analysts are making their best guesses as to what the COLA could be.
Following the most recent consumer price index (CPI) reading from May, The Senior Citizens League updated its forecast. It now expects seniors will get a 2.57% bump in their Social Security checks next year.
That's down from its previous outlook for 2.66% and well below the 3.20% COLA seniors received this year. But a lower COLA could turn out to be a pleasant surprise for retirees.
Image source: Getty Images.
The biggest challenge for Social Security
A higher-than-average COLA is a sign of higher-than-average inflation. And inflation has been extremely detrimental to the value of Social Security.
It has already eaten away at the purchasing power of benefits. The average retiree who started receiving benefits in 2000 has seen their cost of living climb significantly faster than their monthly checks. The Senior Citizens League estimates they've lost about 36% of their purchasing power. That was exacerbated by the high inflation of the last few years.
The way the Social Security Administration calculates the annual COLA is always backward-looking. Since it's impossible to know exactly what inflation will look like going forward, the SSA simply increases payments based on how high living expenses climbed the year before. That means seniors will have to stretch their benefit checks during periods of high inflation.
On the other hand, low and stable inflation is good for Social Security recipients. Social Security's buying power improved the majority of the time the COLA was less than 3% since 2010. Buying power improved by a cumulative 13% across years when the COLA was less than 2% during that period.
Seniors should be cheering for a slow and steady increase in their annual benefits.
Don't forget about the tax bill
Another reason a high COLA is detrimental to the overall wealth of retirees is the taxation of Social Security benefits. Social Security income is taxed based on a metric called combined income.
Combined income is equal to half your Social Security benefits plus your adjusted gross income and any non-taxable interest income. As your Social Security benefits increase, your combined income increases, too, and more of your benefits may become taxable.
The following table shows how much of your Social Security benefits could count as taxable income, based on your combined income and filing status.
| Taxable Percentage of Benefits | Combined Income (Individual Filer) | 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.
Those thresholds might seem low. In fact, they haven't been updated in over 30 years, and there's no inflation adjustment built into the law. So while benefits checks go up, the taxable thresholds stay the same. The result is that more and more seniors are facing bigger tax bills every year.
A low COLA can help you keep more of your Social Security benefits instead of paying taxes.
Where will the 2025 COLA land
The CPI numbers for May came in far better than expected, which led The Senior Citizens League to lower its forecast. But there's still time before the end of the third quarter. Other experts aren't so confident we've fully tamed inflation.
Perhaps the group with the biggest interest in where inflation is headed is the Federal Open Market Committee, or FOMC. The committee is in charge of determining interest-rate policies to support the Fed's goal of full employment and stable inflation. The Fed's current goal is to get inflation back down to 2%.
After the FOMC's most recent meeting, Fed Chairman Jerome Powell indicated the Fed may only make one interest-rate cut before the end of the year. Rate cuts indicate higher confidence that inflation is declining toward the 2% goal, allowing the Fed to loosen the money supply. The committee previously indicated there might be three rate cuts this year, so the current stance suggests it's not as confident rates are coming down.
While the CPI reading for May was good, inflation still increased 3.3% year over year. The Senior Citizens League's forecast suggests practically no changes in pricing from May through the end of September. While that's possible, it seems unlikely.
Still, there's a good chance the 2025 COLA will come in below 3%. While that's down from last year, retirees should still be happy with the result. It means they're more likely to see an increase in the actual purchasing power of their Social Security checks.
