Social Security Benefits Get a Cost-of-Living Adjustment (COLA) in 2025. But There Is a Big Problem for Retirees.

Many Americans lack confidence in their ability to live comfortably through retirement. In fact, a 2023 survey from the Employee Benefit Research Institute (EBRI) found that confidence decreased more significantly last year than at any point since the Great Recession in 2008.

Craig Copeland, director of Wealth Benefits Research at EBRI, attributed the problem to "the current economic climate, in particular inflation." Indeed, prices across the economy increased at their fastest pace in decades post pandemic and inflation remains elevated today. As a result, 55% of the retirees surveyed by EBRI in 2024 worry they will need to make substantial spending cuts.

Of course, the purchasing power of Social Security is theoretically protected by cost-of-living adjustments (COLAs). In fact, benefits received COLAs of 5.9% in 2022 and 8.7% in 2023, two of the largest raises in program history . But that calls into question whether COLAs are truly keeping up with inflation.

Research from The Senior Citizens League suggests Social Security income has lost 20% of its buying power since 2010 because COLAs have consistently underestimated inflation. If payouts had kept pace with inflation, the average retired worker would receive an additional $370 in monthly benefits in 2024, which is equivalent to $4,440 for the full year.

That sizable shortfall may explain why so many Americans lack confidence in their ability finance retirement. Unfortunately, Social Security's 2025 COLA could make the problem worse by once again underestimating inflation. Here are the important details.

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Social Security benefits are on pace to get a below-average COLA in 2025

The Senior Citizens League estimates that Social Security benefits will get a 2.6% cost-of-living adjustment (COLA) in 2025. The chart below shows how a 2.6% COLA would impact the average payout for different beneficiary groups.

Data source: Social Security Administration. Note: Benefit amounts have been rounded to the nearest dollar.

The Social Security Administration cannot calculate the official 2025 COLA until third-quarter inflation data is released in early October. However, if the COLA does indeed land at 2.6%, it would be the smallest raise for beneficiaries since 2021. It would also fall below the 10-year average of 2.75%. But there is another reason retired workers struggling with inflation should be concerned.

Some experts believe Social Security's COLAs should be calculated differently

Social Security's COLAs are based on how inflation changes in the third quarter, the three-month period that runs from July through September. Inflation is measured using a subset of the Consumer Price Index known as the CPI-W. Specifically, the third-quarter CPI-W in the current year is divided by the third-quarter CPI-W from the previous year, and the percent increase becomes the COLA in the following year.

The CPI-W measures inflation based on the spending patterns of hourly workers. Some policy experts see that as a problem. Workers are typically younger than Social Security recipients and young people spend money differently than seniors. For instance, retired workers tend to spend more on housing and healthcare, and less on apparel, education, and transportation. In that context, it does not make sense to determine Social Security COLAs based on changes in the CPI-W.

Indeed, advocacy groups like The Senior Citizens League and the American Association of Retired Persons (AARP) think COLAs should be tied to another subset of the Consumer Price Index known as the CPI-E. The CPI-E measures inflation based on the spending patterns of individuals aged 62 and older, which theoretically makes it a better gauge of pricing pressures on Social Security recipients.

That brings me to the bad news. The CPI-E has outpaced the CPI-W in every month this year. In other words, if the CPI-E is truly a better measure of inflation for Social Security recipients, the 2025 COLA is on pace to underestimate inflation.

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

As shown above, the average CPI-E through the first half of 2024 is three-tenths of a percentage point higher than the average CPI-W. That means Social Security's 2025 COLA is on pace to be three-tenths of a percentage point too low. In other words, benefits will likely lose more buying power next year.

Of course, the official COLA cannot be calculated until October, so the situation could change. But retired workers and other beneficiaries should prepare themselves for another too-small COLA.

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