2025 Social Security COLA increase: What future retirees should know

If you're experiencing less sticker shock when you visit the grocery store or a favorite restaurant these days, that's because inflation finally has calmed down. Still, having seen how much prices can increase in such a short time, you might be concerned about whether your income will keep up during retirement.

To help with this, the Social Security Administration (SSA) provides cost of living adjustments, or COLAs, that increase monthly payouts for current recipients. These adjustments are typically announced every October for the following year. But if you're still a few years out from retirement, will that adjustment affect you? That depends on when you start claiming benefits. Here's what you should know.

The Social Security Administration announced on October 10, 2024 that benefits will increase by 2.5% in 2025, a consistently lower increase over the last few years (3.2% in 2024; 8.7% in 2023).

“Social Security benefits and SSI payments will increase in 2025, helping tens of millions of people keep up with expenses even as inflation has started to cool,” said Martin O’Malley, Commissioner of Social Security.

Nearly 68 million Social Security beneficiaries will see this increase starting in January.

To mitigate the effect of inflation on retirees, Social Security calculates an annual cost of living adjustment for those receiving retirement benefits and disability (technically, Supplemental Security Income). Inflation can be measured in a number of ways, but the SSA relies on a figure known as the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. The administration uses the growth in CPI-W from the third quarter of the previous year until the third quarter of the current year to figure out what that COLA will be.

In years when there's no inflation—something that can occur following an economic downturn—the COLA may be zero. When prices are soaring, meanwhile, the adjustment can be significant. For example, the SSA implemented an 8.7% COLA in 2023 based on the rise of the CPI-W from the third quarter of 2021 to the same quarter in 2022.

The COLA applies to a recipient's primary insurance amount, or PIA, which is what recipients qualify for if they collect benefits at their full retirement age. Suppose, for example, that your PIA was $2,000 a month in 2024. After the 2.5% adjustment, your benefit would increase to $2,050.

A retiree receiving benefits based on their earnings record isn't the only one eligible for the Social Security COLA. Any annual increases also apply to those receiving spousal benefits, survivor benefits and disability benefits.

For current recipients, it's worth bearing in mind that your PIA and the amount you actually collect may not be the same. If you start receiving benefits early, your monthly benefit may be less. If you delay benefits until after your full retirement age, it may be more (though monthly benefit increases stop at age 70). In addition, some older adults have Medicare premiums automatically deducted from their Social Security payouts. Therefore, the change in your monthly benefit may not match the COLA precisely.

Any cost of living adjustments may or may not affect the benefit amount for future recipients, depending on when they apply for Social Security. To understand how this works, it's important to first understand how the SSA calculates retirement benefits.

The basis for your Social Security benefit is a figure known as your average indexed monthly earnings, or AIME. To arrive at your AIME, the program takes the actual earnings for each year you worked and adjusts the years earlier in your career to bring them closer to what you earned after age 60. It then averages your 35 highest indexed earnings years and divides that number by the 12 months of the year. The resulting figure is your AIME. To arrive at your PIA, the administration then applies a specific formula to your AIME based on your first year of eligibility.

Say you have a friend who reached full retirement age in 2024—which happened to be age 66 and 4 months—and applied for Social Security that same year. She could receive any COLAs she had missed out on since becoming eligible for benefits at age 62 in 2020. These increases would be applied to her PIA.

However, if your friend had started claiming Social Security retirement benefits at age 62 when she first became eligible, she would not get COLA adjustments for prior years. You only receive COLA adjustments if you apply for retirement benefits after age 62. Specifically, you get adjustments for any years between your first eligibility (at age 62) and your filing date.

Even if you don't receive any previous COLA increases, your Social Security benefits indirectly take inflation into account. The process of indexing wages to arrive at a PIA means the program is adjusting lower-earning years upward to calculate your benefit. In fact, on average, new beneficiaries receive larger monthly benefits than existing recipients, according to the SSA.

Cost of living adjustments help Social Security recipients weather the impact of rising prices, especially during periods of high inflation. However, not every future beneficiary will see their net income rise by the full amount of the COLA. The reason: A higher income can make more of your Social Security benefit taxable.

The IRS uses your "combined income"—that is, adjusted gross income plus nontaxable interest plus half of your Social Security benefit—to determine the tax status of your Social Security benefits. If you don't receive significant income from wages or investments, you may not have to pay any tax on your monthly benefit. But that changes once your earnings exceed certain thresholds.

For instance:

• If you're unmarried and have a combined income between $25,000 and $34,000, up to 50% of your benefit is subject to income tax. And if your combined income is more than $34,000, up to 85% of your benefit is subject to tax.

• If you're married, up to 50% of your benefits are subject to tax if you have a combined income between $32,000 and $44,000. Up to 85% of your Social Security payment is taxable if your income surpasses that mark.

Because prior COLAs can lead to an increase in tax liability for those who postpone benefits until after age 62, it's important to plan accordingly. When you apply for benefits, you can ask the SSA to withhold federal taxes from your monthly payment so you don't have any surprises during the tax filing season. Working with a financial advisor can provide you with personalized guidance for reducing the impact on your finances.

If you're nearing retirement, the fact that Social Security provides COLAs means your benefit is protected against future inflation. However, the program is only one of multiple sources of income for most older Americans. Consequently, it's imperative that you think about the purchasing power of any other assets you may rely on as well.

Now may be a good time to connect with a financial advisor to evaluate your retirement plan and set up inflation hedges to help support your planned lifestyle and personal goals.