The Social Security Cost-of-Living Adjustment (COLA) Forecast for 2025 Was Just Updated. There's Bad News in Store for Retirees.

Inflation has cooled substantially over the past year, but many retired workers are still struggling with post-pandemic price increases. The statistics below come from the 2024 Retirement Confidence Survey conducted by the Employee Benefit Research Institute and Greenwald Research.

• Less than three-quarters of retired workers believe they have enough money saved to live comfortably through retirement.
• More than two-thirds of retired workers are concerned they will need to make substantial spending cuts to keep up with inflation.

Many retired workers have turned their attention to Social Security's 2025 cost-of-living adjustment (COLA), hoping the additional income will provide some measure of financial respite. But the Senior Citizens League recently revised its COLA forecast down to 2.5%, the smallest benefit increase for retired workers in four years.

Unfortunately, there is more bad news. While the Social Security Administration will not finalize the 2025 COLA until later this week -- the announcement will be made on Oct. 10 -- the official figure will likely underestimate inflation, causing benefits to lose buying power.

Here are the important details.

Image source: Getty Images.

The problem with how Social Security's cost-of-living adjustments (COLAs) are calculated

Social Security's annual cost-of-living adjustments (COLAs) are designed to protect the purchasing power of benefits by ensuring payments increase at the same pace as inflation. To do that, inflation is measured with a subset of the Consumer Price Index known as the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).

The calculation itself is simple: The average CPI-W reading from the third quarter of the current year (July through September) is divided by the average CPI-W reading from the third quarter of the previous year. The percent increase becomes the COLA in the next year. For instance, the average CPI-W reading increased 3.2% in third quarter of 2023, so Social Security benefits got a 3.2% COLA in 2024.

The problem with that approach is the CPI-W measures inflation based on the spending habits of younger, working-age adults. But those people tend to spend money differently than retired workers on Social Security. For instance, from the perspective of retired workers, the CPI-W underestimates the importance of housing and medical care, and overestimates the importance of child care, education, and transportation.

"The CPI-W, in fact, excludes the spending patterns of retired and disabled adults ages 62 and up," according to Mary Johnson, an independent Social Security policy analyst previously associated with The Senior Citizens League. That's problematic because prices tend to increase faster in the spending categories that are more relevant to retired workers, which means the CPI-W tends to underestimate inflation from their perspective.

Social Security benefits are (arguably) on pace to lose buying power in 2025

Experts have suggested swapping the CPI-W for the CPI-E, which measures inflation based on the spending patterns of people aged 62 and older. Comparatively, the CPI-E puts more emphasis on housing and medical care, and less emphasis on child care, education, and transportation, which theoretically makes it a superior inflation gauge for Social Security recipients.

The CPI-E has historically increased more quickly than the CPI-W. Between January 1985 and January 2024, the CPI-E increase 211% and the CPI-W increased 188%, according to the Congressional Research Service. That means Social Security benefits have lost significant buying power over the last few decades if the CPI-E is truly a better inflation gauge for retirees. Unfortunately, that problem is repeating itself in 2024.

Housing expenses (rent equivalence, utilities, furnishings, insurance) have increased more quickly than the overall CPI-W this year, while costs associated with education and transportation have increased less quickly. That means inflation in spending categories more important to retirees is trending above average, while inflation in less important spending categories is trending below average.

The upshot of that combination is CPI-E inflation has increased faster than CPI-W inflation year to date, as shown in the chart below.

Data source: Bureau of Labor Statistics.

As shown above, CPI-E inflation outpaced CPI-W inflation by three-tenths of a percentage point through the first eight months of 2024. That means Social Security's 2025 COLA is (arguably) on pace to underestimate inflation by three-tenths of a percentage point, causing benefits to lose purchasing power next year.

That said, the gap between CPI-E inflation and CPI-W inflation widened to a half-percentage point in August. If that trend persists in the coming months, Social Security's 2025 COLA could underestimate inflation to an even greater degree, in which case benefits would lose even more purchasing power next year.

In light of that bad news, retired workers should continue budgeting prudently. Beyond that, readers looking for additional sources of income should consider certificates of deposit (CDs) or high-yield savings accounts . Interest rates are falling, but they are still elevated compared to the 20-year average.

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