Social Security benefits get annual cost-of-living adjustments (COLAs) to help beneficiaries keep pace with rising prices across the economy. Inflation has moderated in recent months, and that trend is expected to continue, so The Senior Citizens League (TSCL) recently revised its 2025 COLA forecast downward, albeit modestly.
“The 2025 COLA prediction is about 2.57%, down from 2.63% last month,” according to TSCL statistician Alex Moore. The good news is that COLAs are rounded to the nearest tenth of a percentage point, so both estimates imply payouts will increase by 2.6% in 2025. The bad news is that it would be the smallest raise for retired workers since 2021.
However, there is a more serious problem: TSCL estimates Social Security benefits have lost 20% of their purchasing power since 2010 because COLAs have consistently failed to keep pace with inflation. The accuracy of that figure is debatable, but other evidence supports the idea that benefits have lost purchasing power.
Two-thirds of seniors surveyed by TSCL this year said the 2024 COLA failed to cover the increase in their basic household expenses. Additionally, 26% of retired workers surveyed by the Employee Benefit Research Institute said they lacked confidence in their ability to finance retirement. That was the second-worst reading since 2015.
Unfortunately, Social Security’s 2025 COLA may once again underestimate inflation, meaning benefits could lose more buying power next year.
Social Security benefits could lose buying power in 2025
Theoretically, annual cost-of-living adjustments (COLAs) protect the buying power of Social Security benefits by ensuring payouts increase at the same pace as inflation. The COLA applied to benefits in any given year is equivalent to the percent increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) during the third quarter of the previous year, meaning the three-month period between July and September. For that reason, the official 2025 COLA cannot be calculated until third-quarter CPI-W data is available in October.
The CPI-W is a subset of the Consumer Price Index that measures inflation based on the spending patterns of hourly workers. But that methodology makes little sense considering workers tend to be young people who spend money differently from retirees on Social Security. For instance, retired workers typically spend more on housing and medical care and less on education and transportation.
For that reason, several policy analysts and advocacy groups believe COLAs should be based on a different subset of the Consumer Price Index for the Elderly, or CPI-E. The CPI-E measures inflation based on the spending patterns of individuals aged 62 and older, which theoretically makes it a better gauge of how pricing pressures across the economy impact Social Security recipients.
“CPI-E better reflects the changes in prices that older adults face,” according to Richard Johnson, director of the Program on Retirement Policy at the Urban Institute. Similarly, The Senior Citizens League and AARP (formerly the American Association of Retired Persons) have also expressed support for the CPI-E, as have numerous politicians. Indeed, over a dozen bills introduced in Congress during the last decade stipulated that COLAs should be based on the CPI-E.
Unfortunately, if the CPI-E is truly a better gauge of inflation for Social Security recipients, then benefits are on pace to lose buying power in 2025. I say that because CPI-E inflation has exceeded CPI-W inflation every month this year.
|
Month |
CPI-E Inflation |
CPI-W Inflation |
|---|---|---|
|
January |
3.5% |
2.9% |
|
February |
3.4% |
3.1% |
|
March |
3.7% |
3.5% |
|
April |
3.6% |
3.4% |
|
May |
3.6% |
3.3% |
|
June |
3.3% |
2.9% |
|
July |
3.2% |
2.9% |
|
Average |
3.5% |
3.1% |
Data source: U.S. Bureau of Labor Statistics.
As shown above, CPI-E inflation outpaced CPI-W inflation by four-tenths of a percentage point through the first seven months of the year. If the CPI-E is the more accurate metric, then Social Security’s 2025 COLA is on pace to be four-tenths of a percentage point too small. That means benefits will lose buying power next year, provided the trend persists through September, which marks the end of the third quarter.
A small silver lining for Social Security recipients
Not all Social Security experts believe COLAs should be calculated differently. Alicia Munnell, director of the Center for Retirement Research at Boston College, coauthored a paper in 2021 showing that CPI-E inflation was nearly identical to CPI-W inflation between 2002 and 2021. Additionally, Munnell told CNBC in 2022 that benefit increases based on the CPI-W will “fully compensate for inflation” over time.
Much ado has been made about the discrepancy between the CPI-E and the CPI-W in 2023. Specifically, the CPI-W increased by 3.2% in the third quarter last year, so Social Security benefits got a 3.2% COLA this year. But the CPI-E increased 4% in the third quarter last year, meaning Social Security benefits would have increased 4% had the COLA been based on the CPI-E.
However, if Munnell is correct, that discrepancy will average out in time. That doesn’t put extra money in retirees’ pockets today, but it is a small silver lining because it suggests the situation will eventually improve.
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The Social Security Cost-of-Living Adjustment (COLA) Forecast for 2025 Was Just Updated. There’s Good News and Bad News for Retirees. was originally published by The Motley Fool
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