Social Security’s annual cost-of-living adjustment (COLA) helps keep retirees afloat as inflation erodes purchasing power. But this year, it’s sparking some anxiety.
Millions of Americans are facing tough questions about how to stretch their money with a modest 2.5% COLA increase on the horizon — or about $50 a month for the average retirement benefit.
It’s the latest significant drop for the adjustment, which was 3.2% for 2024 and 8.7% in 2023. COLA is based on the increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), so as inflation cools, the adjustment reduces.
This year’s adjustment is closer to the average COLA rate of 2.6% since 2000, and it may feel insufficient as prices for essentials continue to rise. It’s important to note that the CPI-W, the measure used to calculate the COLA, doesn’t fully capture the spending habits of seniors, particularly on healthcare. That mismatch means retirees are falling behind in their purchasing power, even when COLA rises.
If you’re retired or nearing retirement, prioritize creating a budget that factors in rising costs. Consider meeting with a financial planner to explore tools like annuities or high-yield savings accounts to stabilize your income.
Here’s why the change is causing alarm and, more importantly, what else you can do to stay ahead of the curve.
1. Healthcare costs are rising
For retirees, healthcare expenses are unavoidable and increasingly unaffordable. Fidelity Research says a 65-year-old retiring in 2024 can expect to spend an average of $165,000 on healthcare and medical expenses throughout retirement — a 5% jump over the previous year and more than double 2002’s estimate.
For many, Medicare, premiums, copays, and out-of-pocket costs are climbing faster than COLA adjustments can keep up.
PwC projects individual healthcare spending will rise 7.5% in 2025 — the biggest increase in 13 years, driven by inflationary pressure, prescription drug spending and increasing use of behavioral health services.
Retirees using Social Security as a centerpiece of their income rather than a complementary slice may find themselves dipping into savings faster than expected, putting long-term financial security at risk.
Get ready: Explore Medicare Advantage plans or supplemental insurance to manage rising expenses. Additionally, open a Health Savings Account (HSA) if you’re still working and eligible; its triple-tax advantages can help you cover future medical costs.
2. Rising housing costs squeeze budgets
Housing — from rents and mortgages to repairs and insurance premiums — is the largest average annual expenditure category for retirees and costs are still rising. In states with skyrocketing housing costs, some retirees may find that even downsizing is not enough to make ends meet.
In 2021, nearly 11.2 million adults ages 65 and up were cost-burdened, spending more than 30% of their household income on housing costs, the Harvard Joint Center for Housing Studies reported.
And the situation could get worse. In a more recent report, the center noted that declining homeownership among older workers will expose growing numbers of them to rising rents when they retire. Today, 74% of older workers own their homes, down from 80% two decades ago.
Get ready: If you’re struggling with housing costs, consider refinancing, house-sharing, or moving to a more affordable area. Also, research state programs offering property tax relief for seniors.
3. Taxes and Medicare premiums
Many retirees are shocked to learn that a portion of their Social Security benefits can be taxed, and a recent study by the Congressional Research Service found that the proportion of beneficiaries who owe income tax on their benefits is rising and will reach 56% of families by 2050. This again comes down to how the calculations are done.
“The proportion is growing because Social Security benefits are indexed to wage growth and adjusted for inflation, whereas the provisional income thresholds used to determine the taxable amount of Social Security benefits are fixed by statute and not indexed for inflation or wage growth,” said the study. “The taxable amount of Social Security benefits as a percentage of all Social Security benefit payments has grown from 12.2% in 1994 to 38.2% in 2022.”
If you’re single and your combined annual income is more than $25,000 or you’re married with a combined income above $32,000, your benefits may be taxable. President Trump has expressed a desire to do away with these taxes.
On top of that, Medicare Part B premiums are typically deducted from benefits, further shrinking monthly checks.
Get ready: Adjust your investment strategy to reduce taxable income, perhaps by shifting funds to a Roth IRA. A tax professional can help you optimize your withdrawals and minimize your tax burden.
4. Long-term uncertainty of Social Security’s solvency
Social Security’s trust funds will only be able to pay 100% of total scheduled benefits until 2035. Once they are depleted, the program will pay just 83% of scheduled benefits unless Congress takes action.
Although the COLA adjustment for 2025 has caused concern, the deeper worry stems from the program’s uncertain long-term future.
Get ready: Diversify your retirement income sources to reduce reliance on Social Security. Maximize contributions to retirement accounts like 401(k)s and IRAs, and if you’re eligible, delay claiming Social Security benefits to increase your monthly payout.
