It happens every year. Here at the AMAC Foundation’s Social Security Advisory Service we start receiving questions about next year’s Cost of Living Adjustment (COLA) in late September. Sometimes the inquiries come from reporters seeking inside information to include in an article about the topic; or sometimes from those who read the inevitable early media estimates about what the coming year’s COLA may be; and frequently from Social Security recipients sincerely worried about paying their bills next year. But nearly all agree on one thing – Social Security COLA doesn’t adequately keep up with the inflation they are experiencing in the real world. And they are right.

Social Security’s Cost of Living Adjustment methodology was created in 1973 to automatically adjust benefits to keep pace with inflation. The method used looks at the Consumer Price Index for Urban Wage Earners and Clerical Workers (called the “CPI-W”) during the 3rd quarter of the current year (July – September) and compares that to the same period last year. The year-to-year numeric difference in that index translates to a percentage, which becomes COLA for the following year. The federal government does that computation each year in early October and announces next year’s COLA increase on about the 15th of that month. And that is when the inquiries and comments begin in earnest. So why is something so positive as a benefit increase viewed so controversially by some?  Because it’s viewed as insufficient to offset rising prices. Let’s look at why. 

First, the COLA methodology measures inflation which has already been experienced. Whatever the COLA percentage for next year might be, the inflated prices COLA is meant to offset have already been paid by consumers for many months preceding the arrival of any monetary gain in benefits. Thus, the money for inflated goods or services has already been spent and cannot be recovered because ongoing inflation mitigates the buying power of the higher Social Security payment. Yes, we get more money, but we cannot recover money already spent and must still pay ever increasing prices for the goods we now buy. We sometimes hear that “inflation is easing” but that is misleading because it doesn’t mean that consumer prices are going down, it simply means they aren’t rising as fast as they were before.

Inflation affects everything, including healthcare costs. And inflated healthcare costs usually translate to higher Medicare premiums that each person on Medicare Part B must pay. Fortunately, Social Security’s “hold harmless” rule says that a net benefit payment cannot go down as a result of an increase in the standard Medicare premium, which is good news if the standard Medicare premium goes up (as it usually does with inflation). But Medicare Part B premiums are deducted from Social Security, and there’s nothing to prevent Social Security from using your COLA to pay for an increase in your Medicare premium. What that means is that you will, indeed, get a Social Security COLA increase, but some (or sometimes all) of that increase will be used to pay for your new Medicare Part B premium, leaving you with, essentially, little or no extra COLA money to pay for inflated prices for the goods you buy..

Also, “hold harmless” doesn’t extend to other benefit situations. Social Security has a rule that one’s net monthly benefit can never be less, but, as always, there are exceptions to that rule.  COLA will ALWAYS increase the GROSS Social Security payment for every beneficiary, but the net payment someone actually receives can go down, even in times of high inflation. Typically, if someone is affected by the “IRMAA” provision (Income-Related Monthly Adjustment Amount, which affects their Medicare premiums), “hold harmless” will not apply, and their net Social Security payment can actually go down, making it even more difficult to deal with the insidious effects of inflation.

Social Security recently announced that the 2025 COLA increase will be 2.5%. This may seem inadequate, especially when compared to the much higher cost of living for the past few years. But average annual COLA over the past two decades has been about 2.6% per year, so next year’s COLA actually heralds a return to normal for Social Security recipients.  The problem is that “normal” doesn’t actually keep up with inflation that those of us on Social Security deal with every day and many beneficiaries don’t even see the full COLA increase, making their life increasing difficult.

For example, if you claimed a $1,500 Social Security benefit 10 years ago, starting in 2025 your gross monthly Social Security payment would be about $1,977 per month due to annual COLA. But, if you’re on Medicare, you net SS payment will be reduced by your 2025 Medicare premium. The standard Medicare Part B premium has risen nearly 18% over the past 5 years and is estimated to increase by about $10 (to $185 per month) next year.  That amount will be deducted from your Social Security, leaving you with only about $1,792.  In other words, if your 2025 COLA increase adds $48 to your gross Social Security payment, after Medicare you’ll only be left with about $38 to pay those inflated prices. For perspective, food prices have, on average, risen about 26% over the past 5 years, which means the same food you paid $100 for 5 years ago will cost you about $126 today. And add that to other inflated prices for transportation, housing, apparel, recreation, etc., and you will likely see little actual money in your pocket from your COLA increase.  Thus, as important as COLA is to your Social Security income, inflation largely consumes COLA each year, making it impossible to get ahead. Remember, COLA is calculated “after the fact” – you’ve already paid inflationary prices long before you receive any COLA increase. And that’s why COLA cannot (and does not) keep up with actual inflation. Nevertheless, it’s certainly better than no Social Security COLA increase at all. Over time, your Social Security payment would be hundreds of dollars less without it.