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A significant number of retirees are finding that they have to part with a portion of their Social Security benefits.
Social Security plays a critical role in the lives of retirees, with a report by the Center on Budget and Policy Priorities indicating that it has successfully reduced poverty rates among adults aged 65 and over by nearly 75%. The number of seniors living in poverty without this essential program stands at approximately 38.7%, compared to just 10.2% for those receiving benefits as of 2022.
According to over twenty years of annual surveys conducted by Gallup, the financial stability provided by Social Security is indispensable for most retirees. Between 2002 and 2024, a consistent 80% to 90% of retirees have indicated that their monthly Social Security check is a “major” or “minor” source of their income, highlighting the program’s crucial role in their economic well-being.
Given the importance of these benefits, the announcement regarding Social Security’s cost-of-living adjustment (COLA) becomes one of the most anticipated events each year. Although details for the 2025 COLA have been released, some beneficiaries may discover an unexpected challenge in the coming year.
Understanding Social Security’s COLA and its Importance
The cost-of-living adjustment, commonly referred to as COLA, is an annual revision of benefits intended to account for inflation that affects retirees.
For instance, if the price of a typical basket of goods and services purchased by seniors rises by 2%, their benefits would ideally increase by the same percentage to maintain their purchasing power. Essentially, COLA adjustments are implemented to ensure that retirees do not lose ground financially as prices fluctuate.
Before 1975, the determination of Social Security’s COLA was made through sporadic sessions of Congress, with only 11 adjustments issued between the program’s inception in 1940 and 1974. Notably, some of these adjustments were significant, including a staggering 77% increase in 1950.
Since 1975, the calculation of COLA has been anchored to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which includes over 200 spending categories with various weights. Although the CPI-W is updated monthly by the U.S. Bureau of Labor Statistics, only data from the third quarter of the year—specifically the months of July, August, and September—are relevant for determining upcoming COLAs. If the average CPI-W reading for the current year shows an increase from the previous year, inflation is recognized, triggering a corresponding increase in benefits.
The annual percentage change in the average CPI-W from the third quarter is rounded to the nearest tenth of a percent to establish the COLA for beneficiaries.
As inflation has been on an upward trend, beneficiaries have benefited from four consecutive years featuring above-average COLAs. Data from YCharts illustrates how rising inflation has shaped these adjustments.
Beneficiaries to See Increases Amid Continued Inflationary Pressures
During the 2010s, Social Security beneficiaries faced years of disappointing adjustments. In fact, there were three years marked by deflation (where prices decreased), resulting in no COLAs at all for 2010, 2011, and 2016. Furthermore, 2017 saw one of the smallest adjustments ever at just 0.3%.
However, the economic landscape has shifted in recent years, particularly due to substantial fiscal measures taken during the COVID-19 pandemic, which led to a surge in the national money supply and triggered the highest inflation rates in 40 years. Consequently, beneficiaries witnessed substantial COLAs of 5.9% in 2022, 8.7% in 2023 (the largest increase since 1982), and a 3.2% increase for 2024.
Though inflation rates are currently easing, the COLA for 2025 remains robust, coming in at 2.5%, which is still above the average adjustment of 2.3% observed over the last 15 years. This increase is expected to provide an average bump of $49 monthly for retired workers, bringing their benefits to approximately $1,976 in 2025. Meanwhile, those on disability and survivors will see their monthly payouts increase by $38 to around $1,580 and $1,551, respectively.
Challenges Ahead for Some Beneficiaries Due to Tax Implications
While the outlook for Social Security beneficiaries appears positive with the upcoming adjustments, there is a complication that many may not anticipate. Increased benefits could lead to a greater number of retirees facing federal taxes on their Social Security income.
The possibility of taxes on Social Security benefits was established in 1983 when the program’s reserves were nearly depleted. To prevent potential benefit cuts, Congress introduced a system whereby benefits could be taxed for those exceeding certain income thresholds: beginning in 1984, single filers and joint filers with incomes above $25,000 and $32,000 respectively could have their benefits taxed up to 50%. A second tier was introduced in 1993, allowing up to 85% of benefits to be taxed for individuals surpassing $34,000 and couples going over $44,000 in provisional income.
Unfortunately, the thresholds for these taxes have not been adjusted for inflation, meaning that as COLAs continue to raise benefit amounts, an increasing number of retirees find themselves subject to taxes that were initially intended for a smaller group. The 2.5% hike in benefits for 2025 is likely to push even more individuals into this tax bracket.
Despite calls from many seniors for a reevaluation of these taxes, the reality is that they are entrenched and unlikely to change soon. The 2024 Social Security Board of Trustees Report highlights a looming $23.2 trillion funding shortfall facing the program by 2098, emphasizing the need for revenue—including tax income on benefits—to sustain the program’s viability.
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