In May, more than 51 million retired-worker beneficiaries took home an average Social Security check of $1,916.63, which works out to roughly $23,000 on an annualized basis. Although America's top retirement program isn't going to make its recipients rich, the income it provides helps to form a financial foundation for most seniors.

In April, national pollster Gallup surveyed retirees to gauge how necessary their Social Security income is to make ends meet. A whopping 88% of respondents noted that their Social Security payout represents either a "major" or a "minor" source of income. In fact, more than two decades of annual surveys by Gallup have shown that 80% to 90% of retirees would struggle to meet their expenses without Social Security.

With roughly nine out of 10 retirees reliant on their Social Security check in some capacity, it should come as no surprise that the cost-of-living adjustment (COLA) reveal during the second week of October is the most eagerly awaited announcement each year.

Image source: Getty Images.

What purpose does Social Security's COLA serve, and how is it calculated?

As you have probably noticed, the prices of the goods and services you regularly purchase fluctuate. They can increase (known as inflation) or decline (deflation) over time. What Social Security's COLA is tasked with is accounting for price changes in a broad basket of goods and services and ensuring that these shifts are reflected in the income beneficiaries receive.

In simpler terms, if the price for a basket of goods and services that seniors regularly buy increases from one year to the next, Social Security checks should, ideally, rise by the same percentage to ensure that beneficiaries don't lose any purchasing power.

Prior to 1975, there was no rhyme or reason to cost-of-living adjustments. They were passed along arbitrarily by special sessions of Congress, with zero adjustments made during the entirety of the 1940s.

Beginning in 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) became the permanent inflationary measure used by Social Security to calculate annual COLAs. The CPI-W has eight major spending categories and countless subcategories, all of which have their own unique weightings.

These individual weightings are what allow the CPI-W to be broken down to a single figure each month, which can then be easily compared to prior months or years to determine if inflation or deflation has taken place.

Calculating Social Security's cost-of-living adjustment is really simple. The average trailing-12-month CPI-W reading from the third quarter of the current year (only the July through September readings are used in the COLA calculation) are compared to the average CPI-W reading from the third quarter of the prior year. If the average reading increases, inflation has taken place and beneficiaries will receive a bigger benefit in the coming year.

For those who are curious, the percentage difference in the average third-quarter CPI-W reading from one year to the next, rounded to the nearest tenth of a percent, determines the COLA for the upcoming year.

Above-average inflation has lifted COLAs over the last three years. U.S. inflation data by YCharts.

Social Security's cost-of-living adjustment last did this in 1993

Although we don't have any of the CPI-W readings that count toward the 2025 COLA calculation as of yet, the year-over-year CPI-W readings through May 2024 offer big clues as to what's to come. In particular, the CPI-W readings suggest Social Security's COLA is on pace to do something that no one has witnessed since 1993.

In mid-June, the U.S. Bureau of Labor Statistics released the May inflation report, which showed that the CPI-W had risen by 3.3% on a trailing-12-month basis. This was down a tenth of a percent from 3.4% in the April inflation report. (Note: This article was written before the release of the June inflation report on July 11.)

While the prevailing inflation rate moderated ever-so-slightly in May, at least one estimate still suggests Social Security's cost-of-living adjustment can make history in 2025.

According to independent Social Security and Medicare policy analyst Mary Johnson -- who previously worked for nonpartisan senior advocacy group The Senior Citizens League prior to her recent retirement -- the 2025 COLA is on track to come in at 3%.

Based on Social Security's COLA track record over the last two decades, a 3% cost-of-living adjustment is a pretty big deal. Since 2010, there have been three years with no COLA (2010, 2011, and 2016), along with another year that passed along the smallest COLA on record (0.3% in 2017).

But over the last three years, Social Security's cost-of-living adjustments have come in well above the two-decade average of 2.6%. In 2022, 2023, and 2024, beneficiaries saw their checks rise by 5.9%, 8.7%, and 3.2%, respectively. The 8.7% increase passed along last year was the largest since 1982, and the biggest nominal-dollar boost to Social Security checks since the program's inception.

Where things get "historic" is if Johnson's 3% COLA estimate proves accurate. If so, it would mark the first time in 32 years that four consecutive COLAs have totaled at least 3% (COLAs from 1988 through 1993 ranged from 3% to 5.4%).

In dollar terms, a 3% cost-of-living adjustment would increase the average retired-worker benefit by about $57 per month in 2025. Meanwhile, workers with disabilities and survivor beneficiaries would see their monthly payouts increase by an average of $46 and $45, respectively.

Image source: Getty Images.

Retirees continue to get the short end of the stick

On paper, you would think that four straight years of above-average COLAs would have retirees sitting pretty -- but this couldn't be further from the truth.

In May of last year, when The Senior Citizens League issued its 2024 COLA guidance, it also released a study that compared cumulative COLAs since the start of the 21st century to price changes in a large basket of goods and services regularly purchased by seniors. Whereas aggregate COLAs between January 2000 and February 2023 increased benefits by 78%, the dozens of goods and services that retirees typically purchase collectively rose in price by 141.4%.

The end result of The Senior Citizens League analysis is that Social Security income has lost 36% of its purchasing power since this century began.

The biggest issue is that the factors responsible for propping up the prevailing inflation rate are the expenses that matter most to seniors. Compared to the average working American, seniors spend a considerably higher percentage of their monthly budget on shelter and medical care.

Shelter has the largest weighting in the CPI-W of any category. With the Federal Reserve undertaking its most aggressive rate-hiking cycle in four decades, mortgage rates have soared, and sales of existing homes have come to a grinding halt. Not surprisingly, rent inflation has remained stubbornly high, which has provided a boost to the CPI-W.

In recent months, we've also witnessed the inflation rate for medical services picking back up.

Even if Social Security's 2025 cost-of-living adjustment comes in at 3%, or slightly higher than Johnson's estimate, it's unlikely to represent a large enough "raise" to offset the inflation that retirees are currently contending with. In short, retirees are liable to get the short end of the stick, once more, in 2025.