Personal Finance

Your 2025 COLA May Disappoint You. Here's Why It Shouldn't

Christy Bieber

Published: January 23, 2025 9:45 am

If you receive Social Security benefits, your payments are getting bigger this year. That’s because you’re getting a Cost of Living Adjustment or COLA. COLAs happen most years, and they are designed to help you maintain the buying power that your benefits offer

Unfortunately, your 2025 COLA may be a disappointment. That’s because you will see your benefits increase by just 2.5% this year. That’s less than the 3.2% increase you received last year. It’s far less than the 8.7% raise you got in 2024, or the 5.9% benefits increase you saw in 2022.

Although getting less money may not seem great, the reality is that your smaller COLA actually should make you happy, rather than leave you wishing it was larger. Here’s why.

A small COLA is a good thing for retirees

So, how can a smaller raise ever be a good thing? It’s simple. COLAs do not work like a traditional “raise,” which you would get at work. They are not intended to increase your buying power and allow you to purchase more things. Instead, a COLA is intended to help you avoid losing ground as costs rise due to inflation.

There’s a specific formula used to calculate your COLA. The formula starts with the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).  The average CPI-W for the third quarter of the year is calculated. If the third-quarter average is higher than the average during the same time period the year prior, then retirees get a raise based on the percentage increase.

In other words, if CPI-W data shows that a basket of goods and services has gone up 2.5% on average during the year’s third quarter, you get a 2.5% Cost of Living Adjustment.

Because of how this formula works, a small COLA is good news because it means inflation rates are low. A larger COLA is bad news because it means inflation rates are high.  Since retirees benefit when inflation is under control, a small COLA ends up being better than a big one.

Why is inflation a problem for retirees?

Inflation is a big problem for retirees for two reasons.

1. The Social Security benefits formula doesn’t accurately measure the inflation seniors experience. CPI-W is based on urban wage earners –with different spending habits than seniors. Retirees tend to spend more on housing and healthcare, which tend to be areas where prices rise faster than inflation. So, the raise most retirees get is too small even to keep pace with rising prices as it is. The worse the inflation is, the more ground retirees lose due to the imperfect formula.
2. Retirees also rely on savings and investments. Most retirees don’t just get Social Security. They also have money in a high-yield savings account, as well as in an investment portfolio that’s usually invested pretty conservatively due to their short investing timeline. Their investments may not keep pace with inflation, especially during times when price increases are especially high. So, they lose ground on all their other assets.

For all of these reasons, retirees are way better off with a smaller COLA. A small “raise” means their other assets don’t erode in value, and the imperfect COLA formula doesn’t hurt them as much. So, if you’re a senior, be happy with your 2.5% raise this year, and hope for an even smaller one next year.