The disappointing Social Security COLA in 2025 could surprisingly benefit many retirees

The Annual Social Security Cost of Living Adjustment (COLA) is one of the most important features of the government program. Without these annual salary increases, seniors would quickly find that the purchasing power of their monthly pension checks does not meet their needs. For some, this may even be the case with the COLA.

The Social Security Administration announced a 2.5% COLA for 2025 on October 10 of this year. This number is significantly lower than in recent years. The last three years have seen COLAs of 5.9%, 8.7% and 3.2% as inflation rose sharply. But many seniors are still feeling the effects of inflation, and a 2.5% increase in their benefits will have little impact on their grocery bill.

However, for many seniors, there is a surprising benefit of a lower COLA, and it could be much more important than increasing their Social Security check.

The hidden benefit of a low COLA is in your retirement account

Social Security was never intended to replace your income in retirement. At the beginning of the program, many companies offered pensions to their employees. Most people now have private pension provision. Social Security is designed to supplement your retirees' income

t savings.

If you've saved even a small amount in your 401(k) or IRA account while working, you probably have a nest egg to fall back on in retirement. Your retirement account doesn't receive a COLA – it receives the return the market offers. In the long term, investors can expect a balanced stock portfolio to outperform inflation. However, investing in many securities is associated with great volatility.

It's up to retirees to withdraw enough from their retirement accounts to cover their living expenses, regardless of how much their investments have increased (or decreased). Theoretically, the purchasing power of Social Security remains the same year after year. But the purchasing power of your retirement portfolio will be greater during times of low inflation compared to times of high inflation, all things being equal.

Retirees who have significant amounts invested in the market and use those savings to fund a significant portion of their expenses are actually better off in a low inflation, low COLA environment. It appears we are heading in that direction with the 2.5% increase in 2025.

The Impact of Inflation on the Longevity of Your Retirement Portfolio

Another reason many seniors should be happy about the lower COLA is the long-term effect of inflation (the factor that determines your COLA) on withdrawals from your retirement account.

Many people look to a safe withdrawal rate to determine how much they can withdraw from their retirement savings each year. For example, if you use the 4% rule, you will withdraw 4% of your original portfolio balance from the time you retire. If you retire with $500,000 in savings, you will withdraw $20,000 each year. The key is to adjust this payout each year for inflation. So if inflation was 5% this year, you would withdraw $21,000 next year. They will continue to adapt every year.

Prolonged periods of high inflation can completely ruin your safe withdrawal plan. The father of the 4% rule, Bill Bengen, said the biggest threat is inflation, not a bear market or a poor earnings sequence.

We've had relatively high inflation for several years, and it's just starting to come down. Had inflation continued to spike in 2024, it would have resulted in a higher COLA, but could have put a serious strain on many retirees' withdrawal rates. If retirees need to adjust their withdrawals lower to ensure the longevity of their portfolio, that could have a much bigger impact for many than a higher COLA.

While many retirees may have been disappointed by last month's news, the bright side is that the rest of their finances are looking much better due to low inflation.