In March, the nearly 50.7 million retired workers who collected a Social Security benefit took home an average of $1,913.31. Though this might not sound like much, a study from the Center on Budget and Policy Priorities finds that Social Security has lowered the poverty rate for adults 65 and older to 10.2% from an estimated 38.7% if the program didn't exist.
Also, national pollster Gallup has shown that as many as 90% of surveyed retirees said they rely on their Social Security income, in some capacity, to pay their bills.
Given how important Social Security income is to the financial well-being of most retired workers, as well as survivor beneficiaries and workers with long-term disabilities, no announcement is more anticipated than the cost-of-living adjustment (COLA) reveal by the Social Security Administration (SSA) during the second week of October.
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What is Social Security's COLA and how does it affect benefits?
The best way to think about Social Security's COLA is as the mechanism that helps recipients keep pace with inflation. If the price for a collective basket of goods and services regularly purchased by seniors increases, Social Security benefits should, ideally, rise by the same amount to ensure no loss of purchasing power.
Prior to 1975, cost-of-living adjustments were assigned arbitrarily by special sessions of Congress. There were only 11 COLAs passed along between 1940 and 1975, with no inflationary adjustments made in the entirety of the 1940s.
Beginning in 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) became the annual measure of inflation used by the SSA to determine the program's COLA.
The CPI-W has eight primary spending categories and seemingly countless subcategories, all of which have their own respective weightings. These weightings are what allow the CPI-W to be whittled down to a single figure each month, which makes for easy year-over-year comparisons to determine which direction aggregate prices have headed for a broad basket of goods and services.
However, the SSA doesn't rely on a full year's worth of CPI-W readings to calculate its annual COLA. Rather, only readings from the third quarter (July through September) factor into the calculation.
If the average CPI-W reading in the third quarter of the current year increases from the average CPI-W reading in the third quarter of the previous year, inflation has occurred, and Social Security beneficiaries are due a larger payout in the upcoming year. The amount that payouts rise is determined by the year-over-year percentage increase in the average third-quarter CPI-W, rounded to the nearest tenth of a percent.
A reaccelerating inflation rate could increase Social Security's 2025 COLA. U.S. inflation data by YCharts.
Social Security's 2025 COLA estimate is climbing
Over the last three years, Social Security beneficiaries have enjoyed above-average cost-of-living adjustments of 5.9% in 2022, 8.7% in 2023, and 3.2% in 2024. While the 2025 COLA was shaping up to be a bit rough around the edges a few months ago, at least one update suggests payouts will increase by a higher amount than previously forecast.
In February, The Senior Citizens League (TSCL), a nonpartisan group that advances issues important to seniors, provided a long-term COLA forecast for 2025 of 1.75%. When rounded to 1.8%, it implied that the average retired-worker benefit would increase by about $34 a month next year.
But in TSCL's latest update, released on April 10, its long-term COLA forecast for 2025 has been increased to 2.6%, which coincidentally happens to be the average annual COLA over the last 20 years.
This 85-basis-point increase to TSCL's previous 2025 COLA estimate has everything to do with a higher inflation rate for the CPI-W. The U.S. Bureau of Labor Statistics reported a 3.5% year-over-year increase for both the CPI-W and Consumer Price Index for All Urban Consumers (CPI-U) in March. This represents a modest reacceleration in the rate of inflation for both indexes.
Based on the $1,913.31 that the average retired-worker beneficiary took home in March, a 2.6% cost-of-living adjustment would increase benefits by nearly $50 per month next year.
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An unpleasant surprise might await retirees in 2025
On paper, the prospect of a higher-than-anticipated benefit in 2025 probably sounds great to the program's 67 million beneficiaries. But there's more to Social Security's COLA than meets the eye.
The primary reason the inflation rate has remained stubbornly high in recent months is due to shelter inflation. "Shelter" refers to the rental cost of a primary residence, including utilities, or owners' equivalent rent -- i.e., what owners would pay to rent their home, less furnishings and utilities.
Compared to the average worker, seniors pay a higher percentage of their monthly budget to cover shelter expenses. Over the trailing 12 months, shelter inflation in the CPI-U came in at an unadjusted 5.7%. The unpleasant realization for retirees is that even an average uptick in the 2025 COLA to 2.6% would have no chance to offset the higher shelter expenses they're contending with.
In a perfect world, the CPI-W is accurately capturing the inflation that Social Security's 67 million beneficiaries are facing. Unfortunately, the program's inflationary tether is far from perfect.
In May 2023, TSCL released a report that compared aggregate COLAs since the start of this century to the inflation seniors have dealt with from dozens of commonly purchased goods and services. While cumulative cost-of-living adjustments since January 2000 have lifted benefits by 78%, the goods and services studied had collectively jumped in price by 141.4% through February 2023.
Long story short, the purchasing power of a Social Security dollar has withered by 36% since this century began. A 2.6% estimated COLA in 2025 isn't going to make a dent in this steady loss of purchasing power. In fact, rising shelter expenses could exacerbate it.
Social Security's core COLA problem is that the CPI-W measures the spending habits of "urban wage earners and clerical workers." These are prominently working-age Americans who aren't currently receiving a Social Security benefit.
Meanwhile, 86% of Social Security beneficiaries are seniors 62 and above. When compared to the average worker, seniors spend a disproportionate percentage of their budget on shelter and medical care. Since the CPI-W is focused on tracking the spending habits of urban wage earners and clerical workers, important expenses for seniors aren't being given appropriate weighting.
Until lawmakers fix Social Security's measure of inflation, the purchasing power of a benefit's dollar is liable to keep declining.
