Social Security recipients get an annual cost-of-living adjustment (COLA) to protect the purchasing power of benefits from inflation. Retired workers always look forward to those raises, but anticipation surrounding the 2025 COLA is abnormally high due to the challenging economic climate.
Specifically, while inflation has cooled substantially in recent months, rising prices have been a serious burden since the pandemic. In fact, the percentage of U.S. adults that see inflation as their most pressing financial problem reached a record high in 2024, according to Gallup.
The Social Security Administration will announce the official 2025 COLA on Oct. 10, but The Senior Citizens League estimates benefits will increase 2.5% next year. That would be the smallest COLA Social Security beneficiaries have received since 2021. But there is a more serious angle to the situation.
Social Security's 2025 COLA may underestimate real inflation, causing benefits to lose purchasing power. That would be particularly unfortunate because the exact same thing happened in 2024, and Social Security's purchasing power hasn't declined in two straight years since 2021. Read on to learn more.
Image source: Getty Images.
The purchasing power of Social Security benefits is declining
The average Social Security benefit for retired workers was $1,176 per month in December 2010. That figure had increased to $1,860 per month by January 2024. However, The Senior Citizens League (TSCL), a nonprofit group that advocates for Social Security and Medicare, estimates the average retired-worker benefit needed to be 20% higher to fully account for inflation during that period.
To elaborate, the average retired-worker benefit should have been $2,230 in January 2024. That means Social Security's annual cost-of-living adjustments (COLAs) have fallen so far behind inflation that benefits have lost 20% of their purchasing power since 2010. TSCL arrived at that conclusion using a proprietary inflation index weighted to a subset of the Consumer Price Index known as the CPI-E.
Importantly, COLAs are currently calculated with a different subset of the Consumer Price Index known as the CPI-W. But the CPI-W measures inflation based on the purchase habits of workers, a group that spends money differently than retired workers on Social Security. For instance, retired workers often spend more on housing and medical care, and less on apparel, education, and transportation.
The CPI-E is a better fit for Social Security beneficiaries because it measures inflation based on the spending habits of people aged 62 and older. For that reason, several politicians have proposed legislation that would substitute the CPI-E for the CPI-W in the COLA calculation. That includes the Protecting and Preserving Social Security Act recently reintroduced by Sen. Mazie Hirono (D-HI) and Rep. Jill Tokuda (D-HI). But any legislative changes are probably years away at the earliest.
Social Security's COLA in 2025 may do something it hasn't done since 2021
If the CPI-E is truly a better measure of inflation for Social Security recipients, then benefits lose purchasing power in years where the CPI-E increases faster than the CPI-W. That brings me to the bad news: The 2025 COLA is on pace to underestimate CPI-E inflation for the second consecutive year, something that last happened in 2020 and 2021.
In other words, 2025 will mark the second straight year in which Social Security benefits have lost purchasing power. But the problem is actually more serious this time. In 2020 and 2021, the CPI-E outpaced the CPI-W by 0.1% and 0.3%, respectively. By comparison, the CPI-E outpaced the CPI-W by 0.8% in 2023, and it was 0.5% ahead of the CPI-W in August 2024.
That means Social Security benefits are not only on track to lose purchasing power next year, but also the decline in purchasing power is likely to be more severe than it was in 2020 and 2021. In fact, the last time Social Security's COLA underestimated CPI-E inflation so significantly over a two-year period was in 2016 and 2017.
Unfortunately, Social Security recipients have few options for recourse apart from budgeting cautiously and seeking additional income through part-time work. However, the S&P 500 is currently trading near its record high, so now is a reasonable time to sell some stock. Retired workers should also consider keeping money in certificates of deposit (CDs) or high-yield savings accounts. Both could provide additional cash flow next year.
