As the announcement of the new cost-of-living adjustment (COLA) approaches, Social Security beneficiaries, particularly retirees, may face disappointing news. The Federal Reserve has issued warnings that the coming years could see further reductions in these crucial payments, leaving retirees to contend with smaller increases in Social Security benefits. With inflation now under control, the days of substantial Social Security payment increases could be nearing an end.
How Inflation Drives Social Security COLA Increases
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The Social Security Administration (SSA) bases its COLA calculations on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The adjustments are designed to help Social Security payments keep up with inflation, ensuring that retirees maintain their purchasing power over time. Over the past three years, retirees have seen an 18.8% increase in benefits due to high inflation levels, resulting from pandemic-era economic instability.
However, the Federal Reserve’s success in curbing inflation might signal the end of large COLA increases. Social Security beneficiaries should prepare for smaller adjustments in the coming years as inflation continues to decline.
Federal Reserve’s Rate Cut and its Impact on COLA
In September 2024, the Federal Reserve made its first rate cut in four years, reducing the Federal Funds rate by 50 basis points, bringing it down to a range of 4.75% to 5%. This move reflects the central bank’s confidence that inflation is now under control. While the Federal Reserve’s efforts to rein in inflation are good news for the broader economy, it may come as a disappointment to retirees dependent on Social Security.
With inflation slowing, the SSA may have less justification for increasing payments, making it harder for retirees to keep pace with rising living costs. This rate cut does not directly affect the 2025 COLA, but it indicates that the economic conditions fueling the recent surge in Social Security payments are changing.
2025 COLA: A Smaller Increase on the Horizon
Currently, we can estimate the 2025 COLA based on two months of CPI-W data from July and August. According to CBS News, if these figures hold steady, the COLA for 2025 will likely land at around 2.6%, a significant drop compared to previous years. The CPI-W data from August showed a 2.87% increase in July and a smaller 2.35% rise in August. If September follows the trend of slower inflation, the final COLA for 2025 may not exceed 2.6%.
Key drivers of this trend include a reduction in energy prices, particularly in oil, which has fallen below $70 per barrel—its lowest price in over a year. As energy costs play a critical role in the overall inflation rate, their decline suggests that year-over-year inflation will continue to slow, further limiting the scope for a higher COLA.
Preparing for 2026: An Even Lower Adjustment?
Looking ahead, the Federal Reserve has made it clear that inflation will likely continue to decline, with its long-term target set at 2%. According to its projections, inflation will end 2024 at around 2.3% and continue to drop to 2.1% by the close of 2025. This implies that the 2026 COLA may only reach 2.2%, a slight decrease from the expected 2.6% in 2025.
Retirees will need to financially prepare for these lower COLA adjustments. Although the COLA increases are meant to help retirees keep pace with inflation, the figures are backward-looking, based on past economic data, and may not fully account for the current financial challenges retirees face, such as rising costs for necessities like food and energy.
The Silver Lining: Lower Interest Rates Could Help Retirees
While the prospect of smaller Social Security payment increases may seem daunting, there is a potential upside: the Federal Reserve’s interest rate cuts could lead to lower borrowing costs. For retirees with debt, such as mortgages or car loans, the lower interest rates could provide some financial relief. Cheaper borrowing costs might help offset the smaller COLA adjustments, giving retirees a bit more financial flexibility.
In addition, while the COLA is primarily a reactionary adjustment based on past inflation, the overall decline in inflation may help stabilize retirees’ expenses. A lower inflation environment means that retirees may not face the same dramatic increases in the cost of living as they have in recent years.
Conclusion: Time to Plan for the Future
The Federal Reserve’s warning about smaller COLA adjustments for Social Security benefits in 2026 serves as a reminder that retirees need to plan for financial stability in the long term. While recent years have brought generous increases in Social Security payments, the era of large COLA boosts may be coming to an end. Retirees should consider ways to manage their expenses and prepare for the possibility of smaller adjustments in the years ahead. Lower interest rates and controlled inflation may offer some financial breathing room, but proactive financial planning will be essential in navigating the changing economic landscape.
