The yearly announcement regarding the cost-of-living adjustment (COLA) from Social Security is highly awaited, especially by retirees and individuals dependent on benefits. Without the adjustment, many individuals relying on fixed incomes may struggle to cope with rising prices, jeopardizing their retirement plans.
For some, even with the cost-of-living adjustment, managing expenses remains a challenge, especially if the increase falls short of expectations.
Inflation has posed significant challenges in 2024. During the initial quarter of the year, inflation exceeded the 3.2% cost-of-living adjustment, which initially seemed generous. However, expenses quickly escalated, leaving many Americans seeking a financial reprieve. Inflation eased in the latter part of the year, leading to the Social Security Administration announcing a 2.5% cost-of-living adjustment for 2025.
This seems concerning due to the costs seniors faced at the beginning of the year, yet a minimal adjustment offers a glimmer of hope.
The Benefits of a Reduced Cost-of-Living Adjustment for Social Security
It’s important to keep in mind that Social Security was designed to supplement your income in retirement, not to serve as a complete replacement, especially as pensions become less common. To manage costs, individuals are now anticipated to rely on personal retirement savings as their main income source, along with extra benefits.
In many situations, Social Security serves as the main source of income, while assets like 401(k)s or IRAs act as additional support. Having a savings cushion is essential. Benefits are designed to maintain purchasing power, but retirement portfolios should ideally increase in value annually, particularly in times of low inflation.
This situation is advantageous for retirees with substantial investment portfolios, suggesting they can be satisfied with the 2.5% increase that has caused concern for others.
Impact of Inflation on your Retirement Portfolio’s Longevity
For most retirees, the decision to withdraw funds from their portfolio is based on personal judgment and individual needs, unless the account has tax advantages, in which case the IRS will determine the required minimum distribution. Many theories and strategies assert they are the most effective for ensuring investments endure and yield greater returns.
An example of this is the “safe withdrawal rate,” where a specific percentage of your retirement assets is withdrawn annually. Following the 4% guideline means you withdraw 4% of your starting amount annually. If you begin retirement with $500,000, you would take out $20,000 annually, adjusting that amount each year to account for inflation. If inflation is at 5% this year, next year’s withdrawal will amount to $21,000.
This approach is effective only when inflation remains low; an increase in inflation can quickly disrupt this plan. Bill Bengen, creator of the 4% rule, has indicated that inflation is the biggest risk to a withdrawal strategy, more so than bear markets or low returns.
The ongoing epidemic and its consequences have led to a rocky economy, marked by exceptionally high inflation that has significantly impacted the finances and withdrawal rates of retirees. They have had to reduce their withdrawals to maintain their funds for a longer period, which has certainly affected their long-term financial objectives more than a smaller cost-of-living adjustment.
Some retirees might feel let down by the reduced COLA, but the bright side is that lower inflation usually suggests greater stability for their financial well-being. The small adjustment could potentially simplify their financial situation over time.
Reference: Cost-of-Living Adjustment (COLA) Information for 2025