Social Security recipients have long relied on the annual cost-of-living adjustment (COLA) to protect their benefits from inflation. However, the forecast for the 2025 COLA was recently revised downward to 2.5%, the smallest increase since 2021. This revision has raised concerns, especially among retirees already facing financial difficulties due to rising expenses.
Let’s investigate why this revision matters and how it could impact retirees.
COLA
Social Security recipients receive an annual COLA to adjust their benefits based on inflation. This adjustment helps ensure that their benefits maintain purchasing power as the cost of living rises.
The COLA is calculated based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a metric that tracks inflation by measuring the average change in prices paid by consumers for goods and services.
In recent years, retirees have seen some of the largest COLAs in over a decade: 5.9% in 2022, 8.7% in 2023, and 3.2% in 2024. However, despite these seemingly generous adjustments, many retirees say these increases haven’t kept pace with their rising expenses. According to The Senior Citizens League (TSCL), the purchasing power of Social Security benefits has dropped by 20% since 2010.
COLA Forecast
Despite the inflationary challenges faced by retirees, TSCL recently revised its 2025 COLA forecast to just 2.5%. This marks the smallest COLA since 2021 and is significantly lower than the 2022 and 2023 adjustments. The reason for this lower estimate is the downward trend in CPI-W inflation, which has decreased from 2.9% in January to 2.4% in August 2024.
Although the official COLA for 2025 won’t be confirmed until the Social Security Administration releases third-quarter CPI-W data in October 2024, current trends indicate that the final number will likely be around 2.5%.
CPI-W
One of the main criticisms of the COLA calculation is that the CPI-W may not accurately reflect the spending habits of Social Security beneficiaries. The CPI-W is based on the spending patterns of office workers and hourly wage earners, who are typically younger and have different financial priorities than retirees.
Retirees tend to spend more on housing and medical care—categories that have seen higher-than-average inflation. For instance, in August 2024, the cost of housing increased by 4.3%, and medical care costs rose by 3.3%, both of which are above the 2.4% increase in the CPI-W. Since the CPI-W underrepresents these categories, it may understate the true inflation rate experienced by retirees.
CPI-E Compares
To provide a clearer picture, we can compare the CPI-W to the Consumer Price Index for the Elderly (CPI-E), which tracks inflation based on the spending habits of people aged 62 and older. In August 2024, the CPI-E rose by 2.9%, half a percentage point higher than the CPI-W.
This difference highlights the shortcomings of the current COLA calculation, as the CPI-W fails to fully account for the higher costs that retirees face, particularly in essential areas like housing and healthcare.
If the 2025 COLA were based on the CPI-E instead of the CPI-W, Social Security recipients would receive a larger adjustment to better match their actual expenses.
Financial Impact
A smaller COLA, such as the projected 2.5% for 2025, may leave retirees struggling to keep up with rising costs. Many retired workers are already facing financial challenges, with nearly 90% worried about inflation eroding their savings, according to the 2024 U.S. Retirement Survey from Schroders. Less than half of surveyed retirees feel they have enough savings to live comfortably through retirement.
With essential costs like housing and healthcare continuing to rise faster than the broader inflation rate, the smaller COLA for 2025 could result in a further loss of purchasing power for many Social Security recipients.
Retirees
Given the likelihood of a lower COLA in 2025, retirees may need to investigate ways to supplement their income. Here are two options that could help:
- High-Yield Savings Accounts: Interest rates are at their highest levels in decades, and opening a high-yield savings account can generate additional income. These accounts often offer interest rates that significantly outpace traditional savings accounts.
- Certificates of Deposit (CDs): CDs are another low-risk option for retirees looking to grow their savings. With current high interest rates, locking in a CD can provide a reliable source of income over time.
Both options allow retirees to make the most of their savings in a low-risk environment while generating extra cash to offset inflation.
The forecasted 2025 Social Security COLA of 2.5% may leave retirees with less purchasing power, particularly as housing and healthcare costs continue to rise. While the COLA helps cushion the effects of inflation, the current calculation method underrepresents key spending areas for retirees. As a result, many Social Security recipients may face financial difficulties in the coming year.
To combat this, retirees can investigate other sources of income, such as high-yield savings accounts and CDs, to help bridge the gap between their benefits and living expenses. Staying proactive and investigating these options may provide some relief in the face of inflation.
FAQs
How is the Social Security COLA calculated?
The COLA is based on the Consumer Price Index for Urban Wage Earners (CPI-W).
What is the forecasted 2025 COLA?
The 2025 COLA is projected to be 2.5%, the smallest increase since 2021.
Why doesn’t the COLA reflect retirees’ expenses?
The CPI-W, used to calculate COLA, underrepresents costs like housing and medical care.
What is the CPI-E?
The CPI-E measures inflation based on the spending habits of people 62 and older.
How can retirees supplement their income?
Retirees can consider high-yield savings accounts and CDs to grow their savings.
