Editor's note: The author has updated his take on this issue and rewritten some of this article.
Social Security benefits got a 3.2% cost-of-living adjustment (COLA) in 2024, a smaller raise than the historic 8.7% COLA doled out in 2023. Unfortunately, retired workers are on pace to get an even smaller pay bump of 2.6% in 2025, according to The Senior Citizens League, a non-profit advocacy group.
What makes that steady decline surprising is that many seniors report facing financial hardships. The 2023 Retirement Confidence Survey (RCS) conducted by the Employee Benefit Research Institute reported that "58% of retirees are concerned they will have to make substantial cuts to their spending due to inflation."
That number ticked down to 56% this year, but the trend is still intact. In fact, the 2024 RCS found that 26% of retirees lack confidence in their ability to finance retirement, and inflation is the most common reason for that lack of confidence. Those statistics beg the question: Are Social Security benefits actually keeping pace with inflation?
That question is impossible to answer because inflation impacts each person differently. But the 2025 COLA forecast exposes a flaw in the way COLAs are calculated that may shed light on the situation. Read on to learn more.
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There is a major flaw in the Social Security COLA calculation
Social Security benefits get annual cost-of-living adjustments (COLAs) to help retired workers and other recipients keep pace with rising prices. Those COLAs are based on how inflation changes in the third quarter, meaning the three-month period that includes July, August, and September.
Inflation is measured using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a subset of the better known CPI-U. The calculation itself is straightforward: The third-quarter CPI-W in the current year is divided by the third-quarter CPI-W from the prior year, and the percent increase (if any) becomes the COLA in the next year. In that sense, COLAs effectively reimbuse retirees and other Social Security recipients for the buying power benefits lost in the previous year.
That brings me back to the estimated 2.6% COLA in 2025. The forecast is problematic because the CPI-W increased 3.2% during the first quarter of 2024. If we assume the COLA forecast is correct, the CPI-W will have to fall sharply in the fourth quarter for the 2.6% COLA to sufficiently compensate Social Security beneficiaries for lost buying power.
Restated in simpler terms: The COLA calculation is flawed because it applies third-quarter CPI-W data to the full year. I call that method flawed because spikes in the CPI-W during the first, second, or fourth quarters would not impact the COLA calculation. In that scenario, Social Security benefits could fall behind inflation. That actually happened this year.
How the flaw in the Social Security COLA calculation impacted benefits this year
At times, the flaw in the COLA calculation has helped Social Security recipients. For instance, the full-year CPI-W increased 8.5% in 2022, but the third-quarter CPI-W rose 8.7%, so Social Security payments received an 8.7% COLA in 2023. In that situation, the COLA overstated full-year inflation by 0.2 percentage points.
However, the flaw in the COLA calculation has also hurt Social Security recipients at times. For instance, the full-year CPI-W increased 3.8% in 2023, but the third-quarter CPI-W rose 3.2%, so Social Security payments received a 3.2% COLA in 2024. In that situation, the COLA understated full-year inflation by 0.6 percentage points.
That may sound like a small difference, but the discrepancy is more pronounced in dollars. In January 2024, the average retired-worker benefit was $1,907 per month after the 3.2% COLA, but the payout would have been $1,918 per month if the COLA had been 3.8%. That means the average retiree would have received an additional $11 per month (or $132 for the full year) in Social Security benefits if the COLA had matched full-year inflation.
To be clear, the third-quarter CPI-W can understate or overstate full-year inflation, so the flaw in the COLA calculation tends to average out over long periods. However, the flaw can still create intermittent financial challenges for retirees and other Social Security recipients. That's what happened this year, and it could happen again next year.
