Social Security is an important source of income for many retired people. More than two-thirds of senior citizens depend on Social Security for at least half of their income, according to The Senior Citizen’s League.
With prices rising for almost everything, including groceries and healthcare, retirees are feeling the pressure on their budgets.
To help with this, Social Security gives a cost-of-living adjustment (COLA) every year, based on inflation. This is meant to help seniors maintain their standard of living.
In January, retirees received a 2.5% increase in their monthly benefits, which was lower than the 3.2% raise they got in 2024.
2026 COLA Forecast: Smaller But Possibly Better
The early forecast for the 2026 COLA is out, and it suggests that seniors might get an even smaller raise next year. The Senior Citizens League is predicting a 2.3% increase in benefits starting next January.
Although this is lower than the past few years, it could be good news for many retirees. That’s because smaller COLA increases can have positive effects, like reducing the chances of benefits being taxed.
How Is COLA Calculated?
The annual Social Security COLA is based on a measure of inflation called the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W.
This index tracks the prices of goods and services that are commonly bought by people working in cities.
The Social Security Administration compares the CPI-W from the third quarter of the current year to the previous year. If prices have gone up, the COLA for the next year is increased by that percentage.
However, some people believe this method isn’t accurate for seniors because it doesn’t fully reflect their spending habits, especially in healthcare. Since 1987, the Bureau of Labor Statistics has been collecting data on senior citizens’ living costs, called the CPI-E.
Many people think Social Security should switch to using the CPI-E for calculating COLA, as it would better match retirees’ expenses.
Why the COLA Doesn’t Always Help Enough?
Even with COLA adjustments, Social Security is often not enough to keep up with the rising cost of living for many retirees.
A study from The Senior Citizen’s League found that someone who started receiving Social Security in 2010 has lost about 20% of their buying power over the last 15 years.
One of the main reasons for this is that the COLA is always looking backward. It uses the inflation rate from the previous year, so if prices suddenly go up, the adjustment might not be enough to cover current costs.
To make the most of their benefits, retirees should hope for steady and moderate inflation. This would allow the government to provide more accurate COLAs that truly reflect the cost of living increases seniors face each year.
Even though the predicted 2.3% COLA for 2026 is lower than previous years, it could be good news if it aligns better with actual living costs.
How Do Taxes Affect Social Security Benefits?
Another reason retirees might prefer a lower COLA is because of how Social Security benefits are taxed. The government uses a measure called combined income to decide how much of your Social Security benefits are taxable.
Combined income is calculated by adding half of your Social Security benefits to your adjusted gross income and any untaxed interest income. If the total exceeds a certain limit, a portion of the benefits becomes taxable.
The problem is that these income thresholds have not changed in over 30 years, and they don’t adjust for inflation.
This means that even a small COLA increase can push more of your benefits into the taxable range, reducing the actual take-home amount. Therefore, a smaller COLA might help some retirees avoid higher taxes on their benefits.
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What to Expect for the 2026 COLA?
Although it’s still early in the year, inflation saw a jump in January. The Consumer Price Index (CPI) increased by 3% year over year, raising concerns that inflation could stay high throughout the year.
The Federal Reserve is aiming to bring inflation down to 2%, but it has limited tools to achieve this. After reducing interest rates by a percentage point late last year, the Federal Reserve is now taking a wait-and-see approach.
Analysts expect only one or two more rate cuts in 2025, suggesting that inflation might remain above the 2% target for the rest of the year.
If inflation stays high, seniors could continue to face economic challenges in 2025. However, if inflation slows down, it could result in a smaller COLA in 2026, which might be better for many retirees by helping them avoid increased taxes and maintaining a more accurate adjustment to their cost of living.
Final Thoughts: Why a Lower COLA Might Be Good News
While the forecasted 2.3% COLA for 2026 is smaller than in recent years, it might still be beneficial for retirees.
A smaller COLA can help prevent more Social Security benefits from becoming taxable and better match the actual cost of living changes that seniors experience.
Although inflation and other economic factors will continue to influence the final COLA number, retirees should keep an eye on economic trends and be prepared for changes.
By understanding how COLA is calculated and how it affects taxes and purchasing power, seniors can make better financial decisions for the year ahead.
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