Low inflation numbers should ultimately benefit retirees.
Social Security is an essential lifeline for many retirees. About half of households with someone 65 and older get 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 live in poverty.
Since many seniors depend 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 year-over-year price increases in the third quarter. While we haven’t yet reached the third quarter for 2024, analysts are making their best guesses at what the COLA might be.
Following the latest consumer price index (CPI) reading from May, the League of Senior Citizens updated its forecast. It now expects seniors to see a 2.57% increase 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 have 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 damaging to the value of Social Security.
It has already eaten into the purchasing power of the benefits. The average retiree who started receiving benefits in 2000 has seen their cost of living rise significantly faster than their monthly paychecks. The Senior Citizens League estimates that they have lost about 36% of their purchasing power. This was exacerbated by high inflation in recent years.
The way the Social Security Administration calculates the annual COLA is always backwards. Since it’s impossible to know exactly what inflation will look like going forward, the SSA simply increases payments based on the increase in living expenses the previous year. This means that seniors will have to extend benefit checks during periods of high inflation.
On the other hand, low and stable inflation is good for Social Security beneficiaries. Social Security’s purchasing power improved most times the COLA was less than 3% since 2010. Purchasing power improved by a cumulative 13% over the years when the COLA was less than 2% during that period.
Seniors should be cheered for a slow and steady increase in their annual benefits.
Don’t forget about the tax bill
Another reason a high COLA is harmful to retirees’ overall wealth 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 of your Social Security benefits plus your adjusted gross income and any nontaxable interest income. As your Social Security benefits increase, your combined income also increases, and more of your benefits may become taxable.
The table below shows how much of your Social Security benefits can 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.
These thresholds may seem low. In fact, they haven’t been updated in over 30 years and there is no inflation adjustment built into the law. So while benefit checks increase, taxable thresholds remain the same. The result is that more and more seniors are facing larger tax bills each year.
A low COLA can help you keep more of your Social Security benefits instead of paying taxes.
Where the 2025 COLA will land
CPI numbers for May came in much better than expected, prompting the League of Senior Citizens to lower its forecast. But there is still time until the end of the third quarter. Other experts are not so sure that we have tamed inflation completely.
Perhaps the group with the greatest interest in where inflation is headed is the Federal Open Market Committee, or FOMC. The committee is responsible for setting interest rate policies to support the Fed’s objective of full employment and sustainable inflation. The Fed’s current target is to return inflation to 2%.
After the most recent FOMC meeting, Fed Chairman Jerome Powell indicated that the Fed may only make one interest rate cut before the end of the year. The rate cuts indicate higher confidence that inflation is falling toward the 2% target, allowing the Fed to loosen the money supply. The committee previously indicated there could be three rate cuts this year, so the current stance suggests it is not so certain that rates are falling.
While the CPI reading for May was good, inflation again rose by 3.3% year-on-year. The Senior Citizens League forecast suggests virtually no price change from May through the end of September. While this is possible, it seems unlikely.
However, there is a good chance that the 2025 COLA will come in below 3%. While this is down from last year, retirees should still be happy with the result. This means they are more likely to see an increase in the actual purchasing power of their Social Security checks.