Social Security’s 2025 COLA may do something it hasn’t done since 2021 — and it’s not good news

Social Security recipients receive an annual cost-of-living adjustment (COLA) to protect the purchasing power of benefits from inflation. Retired workers always look forward to these raises, but anticipation around the 2025 COLA is abnormally high due to the difficult 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 who see inflation as their most pressing financial problem reached an all-time high in 2024, according to Gallup.

The Social Security Administration will announce the official 2025 COLA on Oct. 10, but the Seniors League estimates benefits will increase 2.5 percent next year. That would be the smallest Social Security COLA recipients have received since 2021. But there’s a more serious angle to the situation.

Social Security’s 2025 COLA may underestimate actual inflation, causing benefits to lose purchasing power. That would be especially unfortunate because the exact same thing happened in 2024, and Social Security’s purchasing power hasn’t declined in two consecutive years since 2021. Read on to learn more.

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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 rose 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’s benefit had to be 20 percent higher to fully account for inflation during that period.

To elaborate, the average benefit for retired workers should have been $2,230 in January 2024. This means that Social Security’s annual cost-of-living adjustments (COLAs) have fallen so much behind inflation that benefits have lost their 20% of purchasing power as of 2010. TSCL arrived at this 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 purchasing habits of workers, a group that spends money differently than retired workers on Social Security. For example, retired workers often spend more on housing and health care and less on clothing, education, and transportation.

The CPI-E is better suited to Social Security recipients because it measures inflation based on the spending habits of people age 62 and older. For this reason, several politicians have proposed legislation to replace the CPI-E with the CPI-W in the COLA calculation. That includes The Social Security Protection and Preservation Act recently reintroduced by Sen. Mazie Hirono (D-HI) and Rep. Jill Tokuda (D-HI). But any legislative change is likely to be several years away at the earliest.

The 2025 Social Security COLA could do something it hasn’t done since 2021

If CPI-E is truly a better measure of inflation for Social Security recipients, then benefits lose purchasing power in years when CPI-E rises faster than CPI-W. That brings me to the bad news: The 2025 COLA is on track to understate CPI-E inflation for the second year in a row, which last happened in 2020 and 2021.

In other words, 2025 will mark the second year in a row that Social Security benefits have lost purchasing power. But the problem is actually more serious this time. In 2020 and 2021, CPI-E outperformed CPI-W by 0.1% and 0.3%, respectively. By comparison, CPI-E beat CPI-W by 0.8% in 2023 and was 0.5% ahead of CPI-W in August 2024.

This means that Social Security benefits are not only on track to lose purchasing power next year, but also that the decline in purchasing power is likely to be more severe than it was in 2020 and 2021. In fact, the last 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 other than prudent budgeting and seeking additional income through part-time work. However, the S&P 500 it is currently trading near record highs, so now is a reasonable time to sell some shares. 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.