What Is a Social Security COLA and How Can It Affect Your Retirement Plan in 2025?

Each year, tens of millions of retirees collecting Social Security benefits anxiously await the upcoming COLA, or cost-of-living-adjustment (COLA). The COLA is a pivotal part of the Social Security program that reflects the next year's increase in Social Security benefits. For instance, if the COLA is 5%, most retirees will see a 5% bump to benefits the next year.

The COLA is intended to maintain the purchasing power of benefits against inflation, which has been notably higher in recent years. Let's dive deeper into how the COLA is calculated, what it will be in 2025, and how it can impact your retirement plan.

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The 2025 COLA

The following year's COLA isn't determined until October of the current year. Because the COLA is effectively meant to hedge inflation, the Social Security Administration (SSA) uses inflation data to determine the COLA.

While the market focuses on the Consumer Price Index for All Urban Consumers (CPI-U) to gauge inflation, the SSA looks at the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Both the CPI-U and CPI-W are published monthly. Specifically, the SSA uses CPI-W data in the third quarter of the year, which is the months of July, August, and September. The CPI-W in each month is compared to the prior year's number. The SSA then takes an average of the percentage differences for each of the three months to arrive at the following year's COLA.

In October, the SSA announced the 2025 COLA would be 2.5%, which happens to be the smallest COLA in four years, although this also means that consumer prices are rising at a slower pace, which should lead to a cheaper cost of living over time. In November, retirees' average monthly benefits check was roughly $1,925, or $23,100 annually. A 2.5% bump would increase the average benefits check to nearly $1,975 or $23,700 annually.

How it can affect your retirement plan

Having a better idea about your future finances can help you budget better and make better financial decisions. Some retirees rely on Social Security to provide most of their income, while others use it to supplement their retirement plans or other income.

Regardless, the nonpartisan Senior Citizens League (SCL) does an annual study that consistently shows Social Security benefits are not keeping pace with inflation. In this year's study, the SCL found that Social Security recipients have lost about 20% of their purchasing power since 2010. So, if retirees can find ways to grow their savings safely and efficiently they may want to consider it.

With most retirees well into their 60s, investing in the stock market may not make sense. However, with interest rates still elevated, retirees may want to look at a certificate of deposit (CD) account at a local bank or credit union. These accounts allow you to lock up your money for a short period ranging from a few months to a few years and earn a more competitive interest rate.

Some financial institutions still pay nearly 5% on CDs of less than one year. That's nearly double the 2025 COLA. Remember, this money is locked up for a set period, so you won't be able to spend it while it's earning interest. If your budget worked in 2024 with last year's benefits, maybe take the extra $500 or $600 in additional projected benefits and put it in a six to eight-month CD. You can check DepositAccounts.com for the best rates.

Another thing retirees should keep an eye on, particularly those earning income from other sources, is potential taxes on benefits. Roughly 40% of people claiming Social Security pay federal taxes on their benefits. This can result from your combined income, which includes Social Security benefits and other income such as wages, interest, dividends, and other taxable income, breaching certain thresholds.

If you file as an individual with a combined income between $25,000 and $34,000, up to half of your benefits could be taxed. If your combined income is above $34,000, you could pay taxes on up to 85% of your benefits. The thresholds for married couples are between $32,000 and $44,000 and above $44,000. Remember, the 50% and 85% numbers are not the tax rate but the amount of benefits that could be taxed. Higher benefits could push a retiree into a new tax bracket. Understanding these tax implications could help you avoid paying taxes on benefits or at the very least prepare you for higher taxes.

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