The Social Security COLA forecast for 2025 has just been updated. There is good news and bad news.

Social Security recipients receive an annual cost-of-living adjustment (COLA) to protect the purchasing power of their benefits from inflation. Even so, many retired workers have struggled to keep up with rising prices. More than two-thirds of Social Security recipients surveyed by The Citizens League said the 3.2 percent COLA applied to payments this year did not offset the increase in their household costs.

The latest data from the Labor Department showed that inflation fell to a three-year low in August. This information was released this week and led to a downward revision to the COLA forecast for 2025. Read on to see why the latest forecast is good news and bad news for retired Social Security workers.

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The good news: The downward revision to the COLA forecast means inflation is cooling quickly

The Senior Citizens League (TSCL) is one of the largest nonpartisan senior advocacy groups in the United States. Following August inflation data, TSCL revised its forecast for the Social Security cost of living adjustment (COLA) in 2025 to 2.5% (was 2.6%). Either way, retired workers and other beneficiaries are on track for the lowest COLA in 2021.

A lower COLA may not sound like good news, but it means inflation is cooling — and that’s a positive development. By design, COLA reimburses Social Security recipients for purchasing power benefits that were lost in the previous year. As a result, beneficiaries are constantly behind the curve, but the financial strain is especially bad when inflation is rising.

Think of it this way: inflation reduces the value of money. If inflation increases every month, money depreciates at an accelerated rate. But if inflation trends lower every month, money depreciates at a decelerating rate. The burden is more bearable in the second scenario, so the reduction in inflation is good news for Social Security recipients, even if it means a lower COLA in 2025.

The bad news: Social Security benefits could lose purchasing power in 2025

Social Security’s annual COLAs are based on the CPI-W, a subset of the Consumer Price Index (CPI) that measures inflation based on the spending patterns of office workers and hourly wage earners. The CPI-W covers eight major expenditure categories that are weighted based on the typical behavior of the target population.

Calculating COLA using the CPI-W is a problem because workers tend to spend Social Security money differently than retired workers. For example, retirees generally spend more on housing and health care and less on transportation and education. The CPI-W does not account for these differences, so it under-emphasizes certain categories of spending and over-emphasizes others.

Many experts believe Social Security’s COLAs should be tied to the CPI-E, a subset of the consumer price index that tracks inflation based on the spending patterns of people age 62 and older. This population overlaps with retired workers to a greater extent, so it should be a more accurate indicator of inflation for these people.

Here’s the bad news: CPI-E inflation is trending above CPI-W inflation in the first eight months of 2024. And the gap between the two numbers widened in August as CPI-E inflation cools less quickly, as shown in the graph below.

Data source: Social Security Administration.

As shown above, CPI-E inflation averaged 3.4% in the first eight months of 2024. This is three-tenths of a percentage point above the CPI-W average.

If the CPI-E really is a better gauge of inflation for retirees, then Social Security’s 2025 COLA will be three-tenths of a percent too low. In other words, Social Security benefits will lose purchasing power next year because COLA will underestimate inflation from the perspective of retired workers.

This is especially concerning because The Senior Citizens League estimates that Social Security has already lost 20 percent of its purchasing power since 2010 as COLAs have consistently fallen short. Unfortunately, any changes to how COLAs are calculated will likely have to wait until Congress resolves the impending insolvency of the Social Security trust fund, and that probably won’t happen for several years.