What it means for retirees and high earners

The Social Security Administration (SSA) has confirmed that a 2.5% cost of living adjustment (COLA) will go into effect in 2025, impacting millions of retirees, survivors, disabled, and Supplemental Security Income (SSI) recipients ). While the increase is lower than in previous years (compared to 2023’s 8.7% COLA and 2024’s 3.2%), experts argue that this smaller adjustment could benefit retirees in the long run, especially because of the current low inflation.

Social Security’s COLA is intended to help beneficiaries maintain purchasing power by adjusting payments based on inflation, as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The SSA calculates the adjustment by comparing the CPI-W of the third quarter of the current year with the same period of the previous year. For 2025, the CPI-W for September provided the final piece of data to confirm the 2.5% adjustment.

However, not everyone is satisfied with the way social security calculates the annual increase. Some advocates argue that the CPI-W does not accurately reflect the spending habits of seniors, who tend to spend a greater share of their income on health care and housing. Some suggest that a more appropriate measure would be the CPI-E, a subset that tracks the spending patterns of Americans age 62 and older. “Many retirees would see their quality of life better preserved if the COLA were adjusted to reflect the true costs of seniors,” the Senior Citizens League argued.

Despite these concerns, there is a silver lining for some retirees in 2025. A lower COLA means inflation remains relatively contained, which benefits retirees who have diversified their savings into retirement accounts, investment accounts or 401(k)s. According to the Federal Reserve, the average household with a head of household age 62 or older had $200,000 in retirement savings in 2022, and the stock market’s performance since then has likely bolstered these balances. Now that inflation has moderated, the purchasing power of these investment accounts can remain stable even without annual Social Security adjustments.

Meanwhile, another major change for 2025 is the increase in the Social Security tax cap, which will rise from $168,600 in 2024 to $176,100. This 4.4% increase will impact higher income earners, who will now pay more into the system. Under current rules, employees contribute 6.2% of their income to social security, while employers match that contribution. However, self-employed people are responsible for the full 12.4%. This adjustment will result in a maximum annual Social Security tax of $10,918.20 in 2025, up from $10,453.20 the year before.

The tax changes have caught the attention of financial planners, especially regarding the impact on the self-employed, who are often hit harder because they cover both the employer and employee portions of Social Security and Medicare taxes. “The 2025 increase means higher-income workers will withhold more payroll taxes, but there is little they can do to avoid it,” said Sean Lovison, founder of Purpose Built Financial Services.

While there is no cap on earnings subject to Medicare taxes, these increases come at a time of growing concerns about Social Security’s long-term solvency. The last trustees report, released in 2024, predicted that the trust funds used to pay out benefits could be depleted by 2035. In response, there is increasing call for reforms to address the funding gap, with some experts calling for increasing or even eliminating funding gaps. the taxable maximum to increase income.

Alicia Munnell, director of the Center for Retirement Research at Boston College, noted that completely eliminating the taxable maximum would provide significant financial benefits to the program. “Abolishing the wage base could be a game-changer for Social Security’s funding problems,” Munnell said, although she acknowledged that such changes could face political hurdles given the uncertainty surrounding future control of Congress and the White House .

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