For most Americans, Social Security is a vital program they couldn't live without. An analysis from the Center on Budget and Policy Priorities found that it pulls 22.7 million people above the federal poverty line each year. Meanwhile, annual surveys from Gallup spanning more than two decades have shown that 80% to 90% of retirees count on their monthly payout from Social Security to cover at least some portion of their expenses.
Considering how important the monthly payouts provided by America's top retirement program are to the financial well-being of its more than 67 million beneficiaries, there's not an event that's more anticipated each year than the cost-of-living adjustment (COLA) reveal in October by the Social Security Administration (SSA).
Image source: Getty Images.
What is Social Security's cost-of-living adjustment (COLA) and how is it calculated?
In its simplest form, Social Security's COLA is the mechanism used to tie benefits to inflation. If, for example, the price for a regularly purchased basket of goods and services by seniors increases from the previous year, Social Security benefits should, in an ideal world, rise by the same amount to ensure no loss of purchasing power. COLA is the tool that attempts to keep benefits on par with inflation.
Before 1975, COLAs were entirely arbitrary and determined by special sessions of Congress. Between 1940 and 1975, only 11 COLAs were passed along to beneficiaries, with none administered in the entirety of the 1940s.
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has served as the program's annual inflationary tether. The CPI-W has more than a half-dozen major spending categories and a multitude of subcategories, all of which have their own respective weightings. These weightings allow the CPI-W to be chiseled down to a single figure, which allows for easy comparisons to the previous month or year to determine if the price for a broad spectrum of goods and services has risen (inflation) or declined (deflation).
What's interesting about Social Security's COLA calculation is it only uses readings from the third quarter (July through September). While the other nine months can help identify pricing trends, they won't factor into the COLA calculation.
If the average CPI-W reading form the third quarter (Q3) of the current year is higher than the average CPI-W reading from Q3 of the previous year, prices have risen and beneficiaries will see a beefier monthly check in the following year. The amount of the increase is simply the year-over-year percentage difference, rounded to the nearest tenth of a percent.
In the rare event that prices fall from the prior year -- which has occurred three times since 1975 -- benefits will remain unchanged in the upcoming year.
A decline in the prevailing inflation rate will likely weigh on Social Security's COLA in 2025. U.S. Inflation Rate data by YCharts.
Two estimates lay out how big Social Security's COLA may be in 2025
Although we're still quite a way from the first month (July) when CPI-W readings actually matter, it hasn't stopped various organizations from issuing estimates for Social Security's 2025 COLA.
In February, the Congressional Budget Office (CBO) issued its annual Budget and Economic Outlook from 2024 through 2034 for Social Security's Old-Age and Survivors Insurance Trust Fund, which covers benefit payments to retired-worker beneficiaries and the survivors of deceased workers. Among these projections was a call for Social Security's COLA to reach 2.5% for 2025.
To offer some context to the CBO's projection, the roughly 50.5 million retired-worker beneficiaries who brought home monthly checks in February received an average of $1,910.79. A 2.5% cost-of-living adjustment added atop this figure would boost benefits for retired workers by almost $48 per month to $1,958.55.
In addition to the CBO offering its take on Social Security's COLA for 2025, the non-partisan, senior-focused advocacy group, The Senior Citizens League (TSCL), provided its own long-term forecast in February. According to TSCL's researchers, the program's long-term COLA forecast in 2025 is 1.75%, which would round to 1.8%.
Based on the same average monthly payout used above for retired workers of $1,910.79, a 1.8% COLA next year would add roughly $34 per month and bring the average check to $1,945.18 next year.
Though these two estimates differ, they both agree on one thing: A lower prevailing inflation rate will lead to a cost-of-living adjustment in 2025 that will come in below the 3.2% COLA that the SSA passed along in the current year.
Image source: Getty Images.
A double dose of disappointment may await retirees in 2025
Over the past three years, Social Security recipients have enjoyed a hearty boost to their monthly payouts, with respective COLAs of 5.9%, 8.7%, and 3.2% passed along in 2022, 2023, and 2024. Unfortunately, a double dose of disappointment likely awaits if the CBO and TSCL are anywhere close to correct with their estimates.
The first disappointment would be the realization that payouts are set to climb by less than the average COLA over the past 20 years of 2.6%. After three years of meaningful benefit "raises," retirees are likely looking at a return to what's been the norm since the Great Recession -- i.e., another subpar increase in their payouts.
The second and far less obvious disappointment is that the purchasing power of Social Security income may decline even further.
In May 2023, TSCL released a report that compared the average inflation that seniors have contended with since the start of the century to the aggregate COLAs they've received over the same period. Whereas COLAs have increased benefits by a total of 78% between January 2000 and February 2023, the cost of dozens of goods and services commonly purchased by seniors had risen by 141.4% over the same span. In other words, the purchasing power of a Social Security dollar had declined by 36% since 2000.
There's a strong likelihood this erosion of purchasing power will persist next year, thanks to stubbornly high shelter inflation (5.7% on a trailing-12-month basis, according to the Consumer Price Index for All Urban Consumers, as of February 2024). Retired workers spend a higher percentage of their income on shelter and medical-care costs than the average American. As long as shelter costs remain high, a 1.8% or 2.5% COLA is unlikely to offset the actual inflation they contend with.
A Social Security dollar simply isn't what it used to be, and the 2025 COLA is likely to reinforce this notion.
