Social Security's 2025 Adjustments: What Retirees Need to Know
Every year in mid-October, Social Security releases a new Fact Sheet documenting annual adjustments based on the past year's inflation. While the Cost-of-Living Adjustment (COLA) often takes center stage, there are several other data points that I find particularly interesting. In today's post, I'll share how I review the annual Fact Sheet release and what these adjustments mean for the financial planning I do with retiree clients. These adjustments are crucial for retirees as they directly impact their income and financial stability in retirement.
2025 Cost-of-living Adjustment Announced (2.5%)
Social Security has announced a 2.5% annual inflation adjustment for beneficiaries in 2025, effective January 2025. This adjustment is lower than last year's 3.2%, indicating that inflation is still occurring in our economy, but at a slower pace than in 2024. To provide context, here's a historical chart of inflation adjustments handed out by Social Security since 1975:
I often receive questions about whether it makes sense to file for Social Security benefits early to benefit from high inflation adjustments (e.g., the 8.7% COLA in 2022). The answer is that you'll benefit from the inflation adjustment regardless of your filing status. If you're still working, your Primary Insurance Amount (the amount you're eligible to receive at your Full Retirement Age) increases by the annual inflation adjustment. However, the longer you wait to file for your Social Security Benefit, the larger the base on which you'll receive the inflation adjustment. For example, someone who waits until 70 and receives a $4,000 monthly benefit with a 2.5% COLA adjustment likely comes out ahead compared to a retiree who takes a smaller benefit at 62 and gets the same 2.5% COLA adjustment.
The inflation adjustment feature of Social Security is one of its best attributes. Fewer retirees now have pensions, and many of those pensions lack an inflation adjustment feature or have caps. For instance, in Tennessee, state employee pensions cap out at a 3% inflation adjustment. While better than nothing, it's not comparable to Social Security's uncapped inflation adjustment. Adding this feature to any financial or insurance product would be incredibly expensive and would pose a significant financial liability for an employer or insurance company.
In my experience, our clients don’t often request annual increases in their investment income withdrawals to account for inflation. As people age, they often naturally spend less, which helps offset the need for annual inflation adjustments in retirement account withdrawals. Additionally, the annual adjustment retirees receive from their Social Security benefits helps cover any increased expenses due to inflation.
2025 Maximum Taxable Earnings Increases ($176,100)
The Social Security Maximum Taxable Earnings is the maximum amount of earned income on which Social Security can charge payroll tax. For 2025, this amount has increased to $176,100. This limit changes each year based on the national average wage index. Here's how it has changed since 1937:
Many people remember the experience of receiving their first paycheck and realizing that not all of the money earned goes into their pocket. One of life's first great financial lessons is that you must give back some of your paycheck to pay for Social Security and Medicare. Whether you're receiving Social Security (and Medicare) or not, as long as you have earned income from a job, you'll pay the 6.2% Social Security tax and 1.45% Medicare Tax if you're an employee. For those who own their own business or are self-employed, the news is less favorable – you pay double that (12.4% for Social Security and 2.9% for Medicare).
There are a couple of observations I'd like to make regarding Maximum Taxable Earnings:
The maximum taxable earnings limit often comes up in discussions about increasing the sustainability of the Social Security benefits program. Some potential legislation has discussed removing the maximum taxable earnings cap altogether, while others propose increasing the payroll tax from 12.4% to potentially above 15%. While no one can predict the future, I anticipate some changes to either of these issues (maximum taxable earnings or payroll tax rate) as we approach the date when Social Security trust funds are scheduled to run out. Although I lean towards fiscal responsibility before applying a band-aid solution with increased taxes, I believe the Social Security system needs to be preserved. Congress tends to act when their backs are against the wall and the clock is about to strike midnight! We're not there yet, but we're inching closer to 2033.
I also have conversations with people who speculate that raising the maximum taxable earnings is a way for the government (Social Security) to unilaterally bring in more money by increasing it at a faster-than-inflation rate. However, inflation experienced over the past year can actually move out of step with wage increases across the economy. In recent years since COVID, employers have struggled to find workers, giving employees an advantage with higher wages. You can see this in the chart above, where wages were growing as fast as, if not slightly faster than, inflation in 2024. As we enter 2025, it's starting to feel like employers have the upper hand again, and we might not see as big of a jump in maximum taxable earnings next year, but only time will tell.
2025 Maximum Social Security Benefit ($4,018/mo)
For someone reaching full retirement age in 2025 (age 67), the maximum Social Security benefit has now surpassed $4,000 per month, reaching $4,018! This applies to individuals who have paid the maximum amount of Social Security benefits throughout their top 35 years of includable earnings. If this describes you, it means you'll have over $48,000 in gross Social Security benefits annually as you move through retirement. For married couples where one spouse has a lower benefit, the survivor benefit ensures that whichever spouse lives longer will receive the higher $4,018 monthly benefit. It's important to note that while $4,018 is the maximum benefit at full retirement age, you can still delay your Social Security benefit until age 70 and receive an 8% annual increase for three more years, potentially capping your Social Security benefit at age 70 at $4,982 per month (approximately $60,000 per year).
Over the years, I've encountered individuals whose goal was to maximize their Social Security benefit and receive the highest possible amount. While this is an impressive achievement, it's not always the best financial decision. Remember, Social Security benefits are paid out progressively. For lower-income workers (imagine someone earning minimum wage for 35 years), Social Security replaces a significant portion of their income (up to 90%, based on the Average Indexed Monthly Earnings bend point formula), depending on when they start receiving benefits. The more you earn and pay into the Social Security program, the less you proportionally receive "back" from it. Workers who qualify for the maximum Social Security benefit have paid a much higher amount into the system and receive a disproportionately smaller return.
For many high-income workers, there's no real work-around for this. However, deferring your Social Security benefits for one more year (and taking income from your Traditional IRA or Roth IRA) will likely do much more for you in the long run than working an extra year or two just to maximize your Social Security benefit.
2025 Earnings Test Exempt Amounts
As I meet with people approaching retirement, the question of how much one can work while receiving Social Security monthly benefits frequently arises. Before delving into the updated earning limitation numbers, it's crucial to remember: Once you reach full retirement age (67 for most people), you can start collecting Social Security benefits and continue working, earning as much as you like through your employer without impacting your Social Security benefits. In other words, once you reach full retirement age, the earnings limitations disappear. It's the period between age 62 and December 31st of the year before your Full Retirement Age that requires careful consideration.
Here are the key earnings test exempt amounts for 2025:
Between ages 62 and December 31st of the year before you reach full retirement age: You can earn up to $23,400 before Social Security starts withholding $1 for every $2 you earn above this amount.
Between January 1st and the month you reach Full Retirement Age: You can earn up to $62,160 ($5,180/month) before Social Security starts withholding $1 for every $3 you earn above this amount.
In most of my planning appointments with near-retirement clients, it's the first window (between age 62 and December 31st of the year before Full Retirement Age) that causes the most issues. Many people would like to start benefits early, but they're still working and earning too much, which would result in reduced Social Security benefits. The second window (January 1st of FRA year to the month you turn Full Retirement Age) comes up less frequently. If you find yourself in either of these windows, I strongly recommend meeting with a financial planner who understands how Social Security works to avoid potential complications. It might mean working one more year or cutting back to part-time hours (don't forget about health insurance before Medicare!) while collecting Social Security.
Conclusion
While Social Security inflation adjustment numbers may not be a date circled on many of our clients' calendars, it's certainly marked on mine! Every year, I find it fascinating to track how the inflation adjustment will impact certain clients' spending patterns for the upcoming year and what adjustments may or may not be needed in the investment portfolios we manage. It's also an annual reminder of the power of Social Security's inflation adjustment capability for the average retiree who is surpassing average life expectancies each year, and it underscores the importance of the financial planning that goes into making these once-in-a-lifetime filing decisions.
It's worth noting that this annual inflation adjustment isn't arbitrary; it's determined by increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). In years where inflation is flat or negative, Social Security benefits remain unchanged – they are not reduced in the case of deflation.
I encourage all readers to review their own Social Security strategies in light of these new numbers. Understanding how these adjustments impact your retirement planning can make a significant difference in your financial security during your golden years.