The Social Security Cost of Living Adjustment (COLA) forecast for 2025 has just been updated. There is good news and bad news for retirees.

Social Security benefits receive annual cost-of-living adjustments (COLAs) 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 modestly.

“The 2025 COLA forecast is around 2.57%, down from 2.63% last month,” according to TSCL statistician Alex Moore. The good news is that COLAs are rounded to the nearest tenth of a percentage point, so both estimates suggest that payments will increase by 2.6% in 2025. The bad news is that it would be the smallest increase for retired workers since 2021 .

However, there is a more serious problem: TSCL estimates that Social Security benefits have lost 20 percent of their purchasing power since 2010 because COLAs have consistently failed to keep pace with inflation. The accuracy of this figure is debatable, but other evidence supports the idea that benefits have lost purchasing power.

Two-thirds of seniors surveyed by TSCL this year said the 2024 COLA failed to cover the increase in basic household expenses. Additionally, 26 percent of retired workers surveyed by the Employee Benefit Research Institute said they lack confidence in their ability to fund retirement. This was the second worst reading of 2015.

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

Image source: Getty Images.

Social Security 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 equivalent to the percentage increase in the Consumer Price Index for Urban Wage and Service Workers (CPI-W) during the third quarter of the previous year, i.e. the three-month period between July and September. For this reason, the official 2025 COLA cannot be calculated until the third quarter CPI-W data is available in October.

The CPI-W is a subset of the consumer price index that measures inflation based on the spending patterns of hourly workers. But that methodology doesn’t make sense, given that workers tend to be young who spend money differently than retirees on Social Security. For example, retired workers typically spend more on housing and health care and less on education and transportation.

For this reason, several policy analysts and advocacy groups believe COLA should be based on a different subset of the Consumer Price Index for Seniors, or CPI-E. The CPI-E measures inflation based on the spending patterns of people age 62 and older, which theoretically makes it a better measure of how price pressures in the economy are affecting Social Security recipients.

“The CPI-E better reflects the price changes that older adults face,” according to Richard Johnson, director of the Retirement Policy Program at the Urban Institute. Similarly, the Senior Citizens League and AARP (formerly the American Association of Retired Persons) have also expressed support for the CPI-E, as have numerous politicians. Indeed, more than a dozen bills introduced in Congress over the past decade stipulated that COLAs should be based on the CPI-E.

Unfortunately, if CPI-E is truly a better indicator of inflation for Social Security recipients, then benefits are about to lose purchasing power in 2025. I say this because CPI-E inflation has outpaced CPI-W inflation every month this year.

Data source: US Bureau of Labor Statistics.

As shown above, CPI-E inflation outpaced CPI-W inflation by four-tenths of a percentage point in the first seven months of the year. If CPI-E is the more accurate value, then Social Security’s 2025 COLA is on track to be four-tenths of a percentage point too low. This means benefits will lose purchasing power next year, provided the trend persists through September, which marks the end of the third quarter.

A small silver lining for Social Security recipients

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

Much ado has been made about the discrepancy between CPI-E and CPI-W in 2023. Specifically, CPI-W rose 3.2% in the third quarter of last year, so Social Security benefits received a COLA of 3.2% this year. But 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, that discrepancy will average out over time. That doesn’t put more money in the pockets of today’s retirees, but it’s a small reason it suggests the situation will improve eventually.