The 2025 Social Security cost-of-living adjustment (COLA) could influence future retirees by preserving the purchasing power of their benefits. COLA adjustments are designed to counteract inflation, ensuring that the primary insurance amount (PIA) reflects current economic conditions. For those delaying retirement, the benefits of COLA compound with delayed retirement credits, potentially leading to substantially higher monthly payments. Understanding how the Social Security COLA affects future retirees can help individuals make informed decisions about when to claim their benefits, maximizing their financial security in retirement.
A financial advisor can help you plan for Social Security and incorporate your benefits into a retirement income plan that is designed to meet your needs. Connect with an advisor today.
How Social Security Benefits Are Calculated
Social Security benefits are primarily determined by an individual’s average indexed monthly earnings (AIME). To calculate the AIME, a worker’s lifetime earnings are adjusted for inflation, and then the highest 35 years of earnings are averaged. This adjustment helps reflect the real value of earnings over time.
The next step involves applying the AIME to a formula to determine the PIA. The PIA is calculated using a three-tiered formula, which applies different percentages to portions of the AIME. This results in a progressive benefit structure, where lower earners receive a higher replacement rate of their pre-retirement income compared to higher earners.
Once the PIA is established, the benefit amount can be adjusted based on the age at which benefits are claimed. Claiming benefits at your full retirement age results in receiving your full PIA. Claiming before your full retirement age reduces your benefit, while claiming after it results in a benefit that’s larger than your PIA. These adjustments ensure that benefits are actuarially fair, providing equivalent value regardless of when they are claimed.
What Is COLA?
The Social Security cost of living adjustment (COLA) is a mechanism that helps maintain the purchasing power of Social Security and Supplemental Security Income (SSI) benefits. It’s an important feature of the Social Security program, designed to provide a safeguard against inflation.
Each year, the COLA is determined based on the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of the previous year to the third quarter of the current year.
When there is an increase in the CPI-W, beneficiaries receive a corresponding percentage increase in their Social Security benefits. This adjustment is automatic and helps beneficiaries keep pace with inflation. However, if there is no increase in the CPI-W, there will be no COLA for that year.
2025 COLA
While the Social Security Administration typically announces the following year’s COLA in October, The Senior Citizens League (TSCL) makes its own projections throughout the year. The non-profit organization that works to protect the rights and interests of seniors estimates that Social Security benefits will rise by 2.63% in 2025.
In 2023, TSCL accurately predicted that Social Security benefits would rise by 3.2%
How Does COLA Impact Future Retirees?
For individuals who have not yet claimed Social Security benefits, COLAs help preserve the purchasing power of their future benefits. The adjustments are applied to the PIA, which is the base figure used to calculate the benefits an individual is entitled to receive at full retirement age.
Each year, if the CPI- indicates inflation, the PIA is adjusted upwards accordingly. This ensures that by the time the individual claims their benefits, the amount reflects the inflation-adjusted value rather than the nominal value at the time of initial calculation.
For those who choose to delay claiming Social Security beyond their full retirement, the benefits increase through delayed retirement credits (DRCs). DRCs boost the benefit amount by a certain percentage for each month of delayed claiming, up to age 70. COLAs enhance the value of these increased benefits because the adjustments are applied to the PIA, which in turn affects the delayed retirement credits. As a result, the longer the delay in claiming, the greater the cumulative impact of both DRCs and COLAs on the final benefit amount.
Understanding the impact of COLAs can help you make strategic decisions about when to claim Social Security benefits. Individuals can weigh the benefits of early claiming against the advantages of delayed claiming, factoring in the cumulative effect of COLAs on their benefits. Those who delay claiming can benefit more from the compounding effect of COLAs on their higher PIA, resulting in significantly larger monthly benefits.
Bottom Line
Social Security cost-of-living adjustments (COLA) affect the primary insurance amount (PIA), which is the basis for calculating your benefits. Delayed retirement credits increase benefits for each year that you delay claiming Social Security beyond your full retirement age, up to age 70. Understanding these factors can help you make informed decisions about when to claim benefits and maximize your financial outcome.
Social Security Planning Tips
- Planning for Social Security benefits can be complex, but using the right tools can make it easier. The SmartAsset Social Security calculator is an invaluable resource for estimating your future benefits. This calculator accounts for your earnings history, expected retirement age and other factors to provide a personalized estimate of your Social Security income.
- A financial advisor can help you plan for Social Security and decide when the right time may be to start claiming your benefits. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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