What Is a Social Security COLA, and How Can It Affect Your Retirement Plan in 2025?

"Inflation is when you pay $15 for the $10 haircut you used to get for $5 when you had hair." - - Former baseball player Sam Ewing

That quotation is amusing -- and it's instructional, too, because it's rather out of date due to inflation . One recent estimate of the average cost of a haircut for men was $28, as of last year, with another source offering a range of $20 to $40.

Image source: Getty Images.

Savvy folks understand that inflation is always with us , to various degrees, and that it will erode the purchasing power of our dollars over time. This can be particularly important for retirees. Imagine, for example, that you retire at age 62. If inflation averages 3% annually over the next 25 years, by the time you're 87 (potentially with another decade of life ahead of you), whatever cost you $100 when you were 62 will cost you about $209 by the time you're 87.

So if you're planning now to be buying a new $35,000 car in the future, it might cost you $50,000 or even $70,000. Anyone engaging in retirement planning (as we all should be doing) should be considering inflation .

Social Security and inflation

When it comes to Social Security and inflation, there's both good and bad news. For starters, Social Security does protect beneficiaries from inflation -- to some degree. It does so via cost-of-living adjustments (COLAs) that happen almost every year. Some people see these as annual "raises," but they are not really increases in your purchasing power. They simply increase your income in an attempt to keep up with the ever-shrinking purchasing power of the dollar.

These COLAs have averaged around 2.6% over the past two decades, but they have occasionally been much higher or lower. Check out some recent Social Security COLAs:

Data source: Social Security Administration.

The upcoming benefit increase for 2025 will be announced in October, and it's expected by many to be around 2.6% -- close to the long-term average.

Social Security's COLA and your retirement

So you can expect inflation-related increases from Social Security throughout your retirement -- but don't expect them to be perfect. Since everyone's spending is different, each year's COLA will offer different degrees of relief. For example, if healthcare costs rise much faster than other expenses and you spend a lot on healthcare, a COLA that's based on a wide range of price categories won't fully make up for healthcare increases.

COLAs are based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which is calculated by the Bureau of Labor Statistics based on changes in the average prices of household goods such as food, housing, and transportation. Some feel that this is not the best measure of inflation for retirees , because it's focused on costs borne by workers, not on retirees' expenses.

A better measure for calculating COLAs is the Consumer Price Index for the Elderly (CPI-E), which counts categories such as healthcare and housing more heavily than the CPI-W index does. Thus, it's been estimated that retirees routinely get a somewhat lower COLA than they should .

Factoring inflation into your retirement planning

As you plan for your retirement , here are some ways to address inflation:

• Try to save aggressively and invest effectively. You might want to save much more than 10% of your income -- and you would do well to invest much of your long-term dollars in stocks, perhaps via a low-fee S&P 500 index fund .
• Plan somewhat conservatively, saving more than you think you need and preparing for the worst. Keep healthcare costs in mind, as they can be substantial in retirement.
• Make the most of tax-advantaged retirement accounts such as IRAs and 401(k)s . Traditional accounts offer upfront tax deductions, while Roth accounts can leave you with tax-free withdrawals in retirement. Paying less in taxes can help offset the effects of inflation.
• Don't plan to rigidly follow a single withdrawal strategy in retirement , such as the helpful-but-flawed 4% rule .
• Consider holding a lot of stock in healthy and growing dividend-paying companies , because dividend payments are often increased regularly and can help you keep up with or exceed inflation.
• Many of us might want to set up multiple income streams for our retirements. These can include Social Security, dividend income, annuity income , income from rental properties, perhaps pension income, and so on. For some people, even a reverse mortgage could make sense.

Finally, while your Social Security COLAs may be underwhelming, you might start planning now to take steps to maximize your Social Security benefits . The bigger they are, the bigger each increase will be. For example, a 3% bump when your benefit check is $2,000 means $60 more, but a 3% bump on a $3,000 benefit is $90.

The $ 22,924 Social Security bonus most retirees completely overlook

If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $ 22,924 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.

View the "Social Security secrets" »

The Motley Fool has a disclosure policy .