Social Security benefits will arguably lose buying power next year because the 2.5% COLA understates inflation.
Inflation has cooled substantially since peaking in June 2022, but elevated prices are still a problem for many retired workers. A recent survey from the Employee Benefit Research Institute, a nonpartisan research organization, found that 56% of retirees are worried they’ll have to make big spending cuts to keep up with inflation.
Social Security benefits will receive a 2.5% cost-of-living adjustment (COLA) in 2025 to compensate for rising prices across the economy. That’s the smallest increase for Social Security beneficiaries since 2021, and most retired workers view the raise as insufficient, according to a recent survey conducted by The Motley Fool.
“The COLA increase is not substantial enough to outpace the growing costs faced by Social Security beneficiaries,” said Kevin Thomson, a finance expert and CEO of 9i Capital Group. “This increase is likely to be overshadowed by rising costs in shelter and medical expenses over the past year.”
Here are the important details.
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Social Security benefits get a 2.5% cost-of-living adjustment (COLA) in 2025
Social Security recipients get annual cost-of-living adjustments (COLAs) to protect the purchasing power of benefits by ensuring payments increase at the same pace as inflation. The metric used to track inflation is a subset of the Consumer Price Index, known as the CPI-W, also called the Consumer Price Index for Urban Wage Earners and Clerical Workers.
The calculation is straightforward: The average CPI-W reading from the third quarter of the current year (i.e., July through September) is divided by the equivalent reading from the previous year. The percent increase then becomes the COLA in the following year. For instance, the CPI-W increased 2.5% in the third quarter of 2024, which means Social Security benefits will get a 2.5% COLA in 2025.
That means the average retired worker will receive an extra $49 per month, or $588 for the full year, according to the Social Security Administration. Unfortunately, that pay increase comes with bad news: It may not accurately reflect the pricing pressures that retirees face, in which case, benefits would lose purchasing power next year.
Social Security benefits are likely to lose buying power in 2025
The CPI-W tracks inflation based on the purchase habits of younger, working-age adults. Certain experts see that as a problem because those people spend money differently than Social Security beneficiaries. In other words, policy experts argue it makes little sense to calculate COLAs for retired workers based on the way younger adults spend money.
The biggest concern is that retired workers generally spend more on housing and medical care and less on education and transportation, compared to young people in the workforce. But the CPI-W is weighted based on the spending patterns of younger adults, so it naturally understates the importance of housing and medical care, and overstates the importance of education and transportation.
The Senior Citizens League, a nonprofit advocacy group, estimates that disconnect has caused Social Security to lose 20% of its buying power since 2010. And the problem is likely to get worse next year. While the overall CPI-W increased 2.5% in the third quarter of 2024, prices in understated spending categories (housing and medical care) rose faster, while prices in overstated categories (education and transportation) rose slower, as detailed below.
- Housing: 4.3%
- Medical Care: 3.4%
- Education: 0.4%
- Transportation: (0.5%)
The Senior Citizens League and several politicians have proposed calculating COLAs using another subset of the Consumer Price Index called the CPI-E, or the Consumer Price Index for the Elderly. The CPI-E measures inflation based on the purchase patterns of individuals aged 62 and older, a group that more closely matches the portion of the population that collect Social Security benefits.
Importantly, the CPI-E increased 3% during the third quarter of 2024, outpacing the CPI-W by a half-percentage point. In other words, Social Security recipients would have recieved a 3% COLA had the pay bump been based on CPI-E inflation. In that scenario, the average retired worker would have received an extra $58 per month in 2025, or $696 for the full year.
That means the COLA applied to Social Security benefits in 2025 will arguably be too small, which is another way of saying Social Security is on pace to lose buying power next year. While certain politicians have proposed swapping the CPI-E for the CPI-W, that change is unlikely to gain traction in Congress any time soon. Social Security is already grappling with a multitrillion-dollar funding shortfall, and larger COLAs would make the problem worse.
On the bright side, retired workers looking for additional income next year have a few good options. Interest rates are elevated, making certificates of deposit (CDs) and high-yield savings accounts attractive. And the stock market has been ripping through all-time highs, which makes the present a reasonable time to sell some stock.
