Social Security benefits are adjusted annually for the cost of living to help recipients keep up with rising prices throughout the economy. Inflation has moderated in recent months, and that trend is expected to continue, so the Senior Citizens League (TSCL) recently revised its 2025 COLA forecast downward, albeit only slightly.

“The COLA projection for 2025 is about 2.57%, up from 2.63% last month,” said TSCL statistician Alex Moore. The good news is that COLAs are rounded to the nearest tenth of a percentage point, so both estimates mean payouts will increase by 2.6% in 2025. The bad news is that this would be the smallest increase for retirees since 2021.

But there’s a more serious problem: TSCL estimates that Social Security benefits have lost 20% of their purchasing power since 2010 because COLAs have consistently failed to keep pace with inflation. The accuracy of that figure is disputed, but other evidence supports the notion that benefits have lost purchasing power.

Two-thirds of seniors surveyed by TSCL this year said the 2024 COLA would not be enough to cover the increase in their basic household expenses. In addition, 26% of retirees surveyed by the Employee Benefit Research Institute said they lacked confidence in their ability to fund their retirement, the second-worst figure since 2015.

Unfortunately, Social Security’s COLA for 2025 could again underestimate inflation, meaning benefits could lose even more purchasing power next year.

Image source: Getty Images.

Social benefits could lose purchasing power in 2025

In theory, annual cost-of-living adjustments (COLAs) protect the purchasing power of Social Security benefits by ensuring that payments increase at the same rate as inflation. The COLA applied to benefits in a given year is equal to the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) in the third quarter of the previous year, the three-month period between July and September. For this reason, the official COLA for 2025 cannot be calculated until the third-quarter CPI-W data are available in October.

The CPI-W is a subset of the Consumer Price Index that measures inflation based on the spending patterns of hourly wage earners. But this method makes little sense when you consider that workers tend to be young people who spend their money differently than retirees on welfare. For example, retirees tend to spend more on housing and healthcare and less on education and transportation.

For this reason, several policy analysts and advocacy groups believe that COLAs should be based on a different subset of the Consumer Price Index for Seniors (CPI-E). The CPI-E measures inflation based on the spending patterns of people ages 62 and older, making it theoretically a better indicator of how price pressures across the economy are affecting welfare recipients.

“The CPI-E better reflects the price changes that older people face,” says Richard Johnson, director of the retirement policy program at the Urban Institute. The Senior Citizens League and AARP (formerly the American Association of Retired Persons), as well as numerous politicians, have also expressed support for the CPI-E. In fact, over a dozen bills in Congress over the past decade have specified that COLAs should be based on the CPI-E.

Unfortunately, if the Consumer Price Index (CPI-E) is a better indicator of inflation for welfare recipients, benefits will lose purchasing power in 2025. I say this because CPI-E inflation has exceeded CPI-W inflation every month this year.

Data source: US Bureau of Labor Statistics.

As shown above, CPI-E inflation exceeded CPI-W inflation by four-tenths of a percentage point during the first seven months of the year. If CPI-E is the more accurate measure, then Social Security’s COLA for 2025 is on track to be four-tenths of a percentage point too low. That means benefits will lose purchasing power next year, assuming the trend continues through September, which is the end of the third quarter.

A small ray of hope for welfare recipients

Not all Social Security experts think COLAs should be calculated differently. Alicia Munnell, director of the Center for Retirement Research at Boston College, co-authored a 2021 paper showing that CPI-E inflation was nearly identical to CPI-W inflation between 2002 and 2021. In addition, Munnell told CNBC in 2022 that benefit increases based on the CPI-W will “completely offset” inflation over time.

Much has been made of the discrepancy between the CPI-E and the CPI-W in 2023. Specifically, the CPI-W rose 3.2% in the third quarter of last year, so Social Security benefits received a 3.2% COLA this year. However, the CPI-E rose 4% in the third quarter of last year, meaning Social Security benefits would have risen 4% if the COLA had been based on the CPI-E.

However, if Munnell is right, this discrepancy will even out over time. While that doesn’t mean that retirees have more money in their pockets today, it is a small glimmer of hope because it suggests that the situation will improve at some point.