The Social Security Cost-of-Living Adjustment (COLA) Forecast for 2025 Was Just Updated. The Outlook for Retirees Remains Grim. | The Motley Fool

The Social Security program undergoes several important changes each year to keep benefits aligned with prices and wages, but the cost-of-living adjustment (COLA) is the most anticipated. COLAs are supposed to reimburse Social Security recipients for the buying power that benefits lost in the prior year. However, whether COLAs are truly serving that purpose is questionable.

For instance, two-thirds of surveyed seniors said the 2024 COLA failed to cover the increased household expenses they incurred last year, according to The Senior Citizens League. Similarly, half of surveyed retirees worry substantial spending cuts will be required to keep up with inflation, according to the Employee Benefit Research Institute.

Those statistics imply that Social Security benefits have lost buying power. Unfortunately, the latest 2025 COLA forecast suggests the situation could get worse next year. Here’s what you should know.

Social Security benefits are (still) on pace to get a 2.6% COLA in 2025

Social Security benefits will get a cost-of-living adjustment in 2025. The size of that COLA depends on how inflation changes in the third quarter (July through September) of 2024. In this scenario, inflation is measured using a subset of the Consumer Price Index known as the CPI-W.

The Social Security Administration cannot calculate the 2025 COLA until September CPI-W data is available in early October. In the meantime, The Senior Citizens League (TSCL) can shed some light on the situation. TSCL is a nonprofit advocacy group that, among other activities, monitors monthly CPI-W data to make predictions about the upcoming COLA.

On July 11, TSCL updated its COLA forecast after the release June CPI-W data. Social Security benefits are now on pace to increase 2.63% next year, up from the previous forecast of 2.57%. That may sound like an improvement, but the numbers are essentially identical. COLAs are rounded to the nearest tenth of a precent, and both figures round to 2.6%.

With that in mind, if Social Security recipients do indeed get a 2.6% COLA next year, the average retired-worker benefit will increase by about $49.77 per month ($597.24 for the full year) and the average spousal benefit will increase by about $23.63 per month ($283.56 for the full year).

Social Security benefits are on pace to lose buying power in 2025

The CPI-W measures inflation based on the spending habits of hourly workers. Some policy experts see that as problematic. Individuals in the workforce tend to be younger than Social Security beneficiaries, most of whom are retired workers, and young people spend money differently than seniors.

Generally speaking, retired workers spend more on housing and medical care, and less on transportation and education. Those discrepancies make the CPI-W a poor measure of inflation where Social Security COLAs are concerned. Joel Eskovitz, senior director of Social Security at AARP, says the Consumer Price Index for the Elderly (CPI-E) is a more appropriate metric for calculating COLAs.

The CPI-E measures inflation based on the spending habits of individuals aged 62 and older, and it places more weight on categories like housing and medical care. The CPI-E typically outpaces the CPI-W by two-tenths of 1% each year. In other words, assuming the CPI-E is truly a better inflation gauge for Social Security recipients, COLAs tend to be two-tenths of 1% too small, meaning benefits are slowly losing buying power.

Unfortunately, that trend has been more pronounced in 2024. The table below shows how the CPI-E and CPI-W have changed in each month of this year so far:

Data source: U.S. Bureau of Labor Statistics.

As shown above, CPI-E inflation has outpaced CPI-W inflation by three-tenths of 1% year to date. That means the 2025 COLA is on pace to underestimate inflation by a wider-than-normal margin. As a result, benefits are set to lose an above-average amount of buying power next year.

Remember, TSCL expects a 2.6% COLA next year. That estimate is based on CPI-W inflation, but the chart above suggests the COLA needs to be three-tenths of 1% higher to keep up with CPI-E inflation. The difference between a 2.6% COLA and a 2.9% COLA is not a huge sum — about $6 per month for retired workers and $3 per month for spouses — but every dollar matters, and lost buying power adds up over time.

Additionally, the latest COLA forecast was particularly grim because the gap between the CPI-E and CPI-W has now widened for two straight months. If that trend persists, the 2025 COLA may underestimate inflation to an even greater degree than three-tenths of 1%, meaning benefits could lose even more buying power.