The 2025 Cost of Living Adjustment (COLA) may not increase your monthly benefits as much as you think

Seniors collecting Social Security get a raise almost every year to help their checks keep up with the rising cost of living. The government is still weeks away from finalizing the numbers to calculate next year’s cost of living adjustment, or COLA. If all goes as expected, Social Security recipients should receive a 2.5 percent increase in their benefits starting in January.

This number may be disappointing after 2023’s 8.7% COLA and this year’s 3.2% adjustment. In addition, many seniors may not even see a 2.5% increase in their monthly checks. Here’s why.

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The cost of Medicare is rising faster than inflation

The Social Security Administration (SSA) automatically deducts Medicare Part B premiums from beneficiaries’ checks if they are enrolled in the government-sponsored health insurance program. You become eligible for Medicare at age 65, and the SSA will automatically enroll you in Part A and Part B if you’ve already collected retirement or disability benefits.

The cost of Medicare premiums increases each year to cover healthcare costs for America’s elderly. The Medicare Board has projected an increase in the monthly Part B premium for most households from $174.70 to $185.00. That’s a 5.9% increase in costs, far more than the projected COLA of 2.5%.

In other words, the average Social Security recipient currently receives $1,872 in monthly retirement benefits. A 2.5% increase over that average is $46.80 per month, but about $10.30 of that will go toward paying higher Medicare premiums. As a result, the average beneficiary will only receive an increase of approximately 2.2% on current checks.

Don’t forget the taxes

The Social Security Administration will withhold taxes from your monthly checks only if you request it, and then only at predetermined percentages, ranging from 7% to 22%. But whether the SSA withholds taxes from your monthly check or not, next year’s COLA is likely to come with an additional tax burden for many retirees.

The way the federal government taxes Social Security is based on a measure called combined income, which is equal to half of your Social Security benefits, plus your adjusted gross income and any untaxed interest income. If your combined income exceeds certain thresholds, a portion of your Social Security benefits is considered taxable income that is subject to federal income tax.

Here are the thresholds:

Data source: Social Security Administration.

As you can see, those thresholds are extremely low. In addition, the SSA does not adjust them for inflation. As such, more and more seniors are seeing more and more of their benefits become taxable each year.

When considering the impact of the COLA on your net income, consider the COLA’s marginal tax rate. If 85% of your COLA is taxable at the 12% or 22% tax rate, that’s a 10% or 19% decrease in the actual COLA value for your budget, respectively. Additionally, you may be subject to tax on state income for your Social Security benefits if you live in one of the nine states.

Get your Social Security COLA

Understanding how the factors above affect your monthly Social Security benefit is half the battle in making sure you get the most out of your COLA. While there’s not much you can do to avoid the rising cost of health insurance and health care, the Social Security program has some built-in protections.

The hold harmless provision ensures that your Medicare premium will not increase more than your Social Security benefit. That said, it could eat up the entire amount of your benefit increase.

When it comes to taxes, understanding the factors that go into your combined income is the first step. Combating Social Security taxation effectively requires advanced planning and paying taxes up front to avoid higher taxes later. The most commonly used tool is the Roth conversion, which allows you to pay taxes now to make tax-free withdrawals in the future. You may also be able to strategically take capital losses to offset capital gains to keep your adjusted gross income low while you live off your investments.

For many seniors, however, the reality is that next year’s COLA will not produce the expected increase in spending power that the headline number might suggest.