The Social Security Cost-of-Living Adjustment (COLA) Forecast for 2025 Was Just Revised Lower, but Retirees May Have a Bigger Problem

Social Security recipients get an annual cost-of-living adjustment (COLA) to protect the buying power of their benefits from inflation. However, more than two-thirds of retirees surveyed by The Senior Citizen Leagues said the 3.2% COLA in 2024 was too small, meaning benefits did not increase enough to cover their elevated expenses.

Unfortunately, those retirees may face more financial difficulties next year. Social Security benefits were already projected to get a smaller COLA in 2025, but the forecasted pay raise was recently revised even lower. Additionally, the fact that so many retirees are struggling with inflation suggests that benefits have lost buying power, which could signal a bigger problem.

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Social Security benefits could get a 2.6% cost-of-living adjustment in 2025

The Senior Citizen League (TSCL), a nonprofit advocacy group, estimated last month that Social Security benefits would get a 2.7% cost-of-living adjustment (COLA) in 2025.

That forecast was recently revised lower because inflation cooled more than anticipated in May. Social Security benefits are now on pace to get a 2.6% COLA next year, according to TSCL statistician Alex Moore. That aligns with the estimate from the Social Security Board of Trustees.

The chart below shows how a 2.6% COLA would impact the average monthly benefit paid to different Social Security recipients.

Data source: Social Security Administration.

Some retirees would undoubtedly be disappointed if Social Security benefits got a 2.6% COLA next year. It would be a smaller raise than the 3.2% COLA this year, and a much smaller raise than the 8.7% COLA last year. That would be particularly bad news for anyone already struggling to make ends meet.

However, Social Security recipients may have a bigger problem: Benefits may be losing buying power due to the way COLAs are calculated.

Social Security benefits may lose buying power in 2025

The Social Security Administration determines COLAs based on how inflation changes in the third quarter (July through September). Inflation is measured using a subset of the Consumer Price Index known as the CPI-W, which tracks prices based on the spending habits of hourly workers.

The calculation is simple. The CPI-W in the third quarter of the current year is divided by the CPI-W in the third quarter of the previous year, and the percent increase becomes the COLA in the next year. For instance, the third-quarter CPI-W increased 3.2% in 2023, so Social Security benefits got a 3.2% COLA in 2024.

However, numerous pundits and politicians dislike the CPI-W because it's based on the spending habits of workers. That is problematic because workers spend money differently than retirees on Social Security. For instance, retirees usually spend more on housing and healthcare. For that reason, some experts believe COLAs should be tied to the Consumer Price Index for the Elderly (CPI-E), which tracks prices based on the spending habits of individuals aged 62 and older.

Here's the problem: If the CPI-E is a better measure of inflation for Social Security recipients, then the 2025 COLA will almost certainly be too small, in which case benefits would lose buying power. I say that because the CPI-E has been increasing faster than the CPI-W, as shown in the chart below.

Data source: The U.S. Bureau of Labor Statistics.

As shown above, the CPI-E has increased three-tenths of a percentage point faster than the CPI-W through May. If that trend holds, Social Security's 2025 COLA will (arguably) underestimate inflation by 0.3%. In that scenario, the average retired worker would be shorted about $5.75 per month or $69 for the full year. While not an extraordinary sum of money, every dollar can make a difference.

Importantly, Social Security beneficiaries ran into the same problem last year. The third-quarter CPI-W increased 3.2% in 2023, but the third-quarter CPI-E increased 4%. In other words, while Social Security payments increased 3.2% this year, benefits arguably should have increased 4%. That may explain why so many retirees are struggling to keep pace with inflation.

There is good news and bad news. The good news is many politicians have proposed using the CPI-E to calculate COLAs, and that change could one day become law. The bad news is that won't happen in the near future, so it doesn't help retirees struggling with inflation today. The best thing those individuals can do is budget prudently and try to earn extra income, be it through a part-time job, a high-yield savings account, or reliable dividend stocks or index funds.