Tens of millions of pensioners collect every year Social security benefits eagerly await the upcoming COLA, or cost-of-living adjustment (COLA). The COLA is a key part of the Social Security program that reflects next year's increase in Social Security benefits. For example, if the COLA is 5%, most retirees will see a 5% increase in benefits next year.
The COLA is intended to maintain the purchasing power of benefits against inflation, which has been significantly higher in recent years. Let's dive deeper into how the COLA is calculated, what it will be in 2025, and how it may affect your retirement plan.
The COLA for the following year is not set until October of the current year. Because COLA is effectively designed to hedge inflation, the Social Security Administration (SSA) uses inflation data to determine COLA.
While the market focuses on the Consumer Price Index for All Urban Consumers (CPI-U) to measure inflation, the SSA focuses on the Consumer Price Index for Urban Employees and Administrative 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 are the months of July, August, and September. Each month's CPI-W is compared to the previous year's figure. The SSA then averages the percentage differences for each of the three months to arrive at the following year's COLA.
In October SSA announced COLA 2025 would be 2.5%, which happens to be the smallest COLA in four years, although that also means consumer prices are rising more slowly, which should lead to a cheaper cost of living over time. In November, the average monthly check for retirees' benefits was about $1,925, or $23,100 a year. A 2.5% increase would raise the average benefit check to nearly $1,975, or $23,700 a year.
Having a better idea of 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) conducts an annual study that consistently shows that Social Security benefits are not keeping pace with inflation. In a study this year, SCL found that Social Security recipients have lost about 20% of their purchasing power since 2010. So if retirees can find ways to safely and efficiently grow their savings, perhaps they should consider it.
Since most retirees are already in their 60s, investing in the stock market may not make sense. However, with interest rates still elevated, retirees may want to look into a certificate of deposit (CD) account at a local bank or credit union. These accounts allow you to lock in your money for a short period of time ranging from a few months to a few years and get a more competitive interest rate.
Some financial institutions still pay close to 5% for CDs of less than one year. That's almost double COLA 2025. Remember, this money is locked up for a set period of time, 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 an extra $500 or $600 in additional planned benefits and put them into a six- to eight-month CD. You can check DepositAccounts.com at the best prices.
Another thing that retirees should be aware of, especially those with income from other sources, is potential tax on benefits. About 40% of people who qualify for 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 that exceeds certain thresholds.
If you file as an individual with a combined income between $25,000 and $34,000, up to half of your benefits may be taxed. If your combined income is more than $34,000, you can 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 that the 50% and 85% numbers are not the tax rate, but the amount of benefits that could be taxed. Higher benefits could push retirees into a new tax bracket. Understanding these tax implications can help you avoid paying taxes on benefits, or at least prepare you for higher taxes.
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