Social Security’s annual cost-of-living adjustment, known as COLA, is fundamental to the government program. Without these increases that are made every year, seniors would soon notice that the purchasing power of their monthly checks would not cover their needs. Even with COLA, some may feel that limitation.
On October 10, the Social Security Administration made the announcement about the 2.5% adjustment for 2025.
This figure is notably lower than in previous years, when the adjustments were 5.9%, 8.7% and 3.2% due to inflation. However, many beneficiaries are still suffering from the effects of inflation, and a 2.5% increase in their benefits will not significantly alleviate their expenses.
The hidden advantage of a low COLA in Retirement
A lower COLA has a big advantage for many retirees, and it could be more important than the increase in your Social Security check. The hidden advantage is found in the retirement account. Social Security was never intended to replace income during retirement; It started at a time when companies offered pensions. Now, most people depend on private savings and Social Security supplements this income.
If you saved in a 401(k) or IRA, you likely have a nest egg for retirement. These types of accounts do not receive cost-of-living adjustments, but they do receive whatever returns the market offers. Over the long term, a balanced portfolio of stocks could outperform inflation, although investing in many securities can be volatile. A well-managed retirement account can be essential during retirement.
Retirees and inflation — how to manage living costs in times of economic uncertainty
Retirees should make sure they withdraw enough from their retirement accounts to cover their living costs, no matter how their investments fluctuate. In theory, the purchasing power of Social Security remains constant every year, but that of your retirement portfolio will be greater in periods of low inflation compared to high inflation, all things being equal.
Therefore, retirees with representative investments in the market, who use those savings to finance a significant part of their expenses, will be better off in an environment of low inflation and low cost of living. With the 2.5% increase in 2025, it appears we are moving in that direction.
The Long-term impact of a low COLA Increase on retirement withdrawals and its benefit for seniors
Another reason many seniors should be happy about a lower COLA is the long-term impact of inflation on their retirement account withdrawals. Many people follow a safe withdrawal rate to determine how much they can withdraw year to year. For example, using the 4% rule, they will withdraw 4% of their initial portfolio balance when they retire.
If they retire with $500,000 in savings, they will withdraw $20,000 a year. The key is to adjust that withdrawal for inflation every year. So, if inflation was 5% this year, they will withdraw $21,000 the following year and continue adjusting annually. This strategy helps maintain the purchasing power of your savings over time.