Social Security benefits got a 3.2% cost-of-living adjustment (COLA) in 2024, a smaller raise than the historic 8.7% COLA doled out in 2023. Unfortunately, retired workers are on pace to get an even smaller pay bump of 2.6% in 2025, according to The Senior Citizens League, a non-profit advocacy group.
What makes that steady decline surprising is that many seniors report facing financial hardships. The 2023 Retirement Confidence Survey (RCS) conducted by the Employee Benefit Research Institute reported that “58% of retirees are concerned they will have to make substantial cuts to their spending due to inflation.”
That number ticked down to 56% this year, but the trend is still intact. In fact, the 2024 RCS found that 26% of retirees lack confidence in their ability to finance retirement, and inflation is the most common reason for that lack of confidence. Those statistics beg the question: Are Social Security benefits actually keeping pace with inflation?
That question is impossible to answer because inflation impacts each person differently. But the 2025 COLA forecast exposes a flaw in the way COLAs are calculated that may shed light on the situation. Read on to learn more.
Image source: Getty Images.
There is a major flaw in the Social Security COLA calculation
Social Security benefits get annual cost-of-living adjustments (COLAs) to help retired workers and other recipients keep pace with rising prices. Those COLAs are based on how inflation changes in the third quarter, meaning the three-month period that includes July, August, and September.
Inflation is measured using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a subset of the better known CPI-U. The calculation itself is straightforward: The third-quarter CPI-W in the current year is divided by the third-quarter CPI-W from the prior year, and the percent increase (if any) becomes the COLA in the next year.
Here’s an example: The CPI-W increased 3.2% in the third quarter of 2023, so Social Security benefits increased 3.2% in 2024. In that sense, COLAs effectively reimburse retirees and other Social Security recipients for the buying power benefits lost in the previous year.
That brings me back to the estimated 2.6% COLA in 2025. The forecast is problematic because the CPI-W increased 3.2% during the first quarter of 2024. If we assume the COLA forecast is correct, the CPI-W will have to fall sharply in the fourth quarter for the 2.6% COLA to sufficiently compensate Social Security beneficiaries for lost buying power.
Restated in simpler terms: The COLA calculation is flawed because it extrapolates third-quarter CPI-W data to the full year. That only works if CPI-W inflation rises and falls smoothly over long periods, such that any discrepancies between the annual change in CPI-W and Social Security COLAs average out over time.
However, the current methodology would be problematic if the CPI-W regularly spikes in the first, second, or fourth quarters. In that scenario, the annual change in CPI-W could regularly exceed the Social Security COLA, meaning consumer prices could consistently increase faster than benefits. Unfortunately, that has happened more often than not over the past decade.
How the flaw in the Social Security COLA calculation has impacted benefits
The CPI-W increased most sharply in the first quarter during 2017, 2020, and 2023. It increased most sharply in the second quarter during 2014, 2018, 2019, and 2022. And it increased most sharply in the fourth quarter during 2016 and 2021. In other words, inflation peaked before or after the third quarter in 9 of the last 10 years.
Put differently, 9 of the last 10 COLAs did not account for the most aggressive increases in consumer prices. As a result, CPI-W inflation increased more quickly than COLAs over the last decade, meaning Social Security benefits (arguably) lost buying power.
The chart below shows the average and total increases in the annaul CPI-W, as well as the average and total increases in Social Security benefits (i.e., the COLAs) over the last decade.
|
Year |
CPI-W (Percent Change) |
Social Security COLA |
|---|---|---|
|
2014 |
1.5% |
1.5% |
|
2015 |
(0.4%) |
1.7% |
|
2016 |
1% |
0% |
|
2017 |
2.1% |
0.3% |
|
2018 |
2.5% |
2% |
|
2019 |
1.7% |
2.8% |
|
2020 |
1.2% |
1.6% |
|
2021 |
5.3% |
1.3% |
|
2022 |
8.5% |
5.9% |
|
2023 |
3.8% |
8.7% |
|
Average |
2.7% |
2.6% |
|
Total |
30.4% |
28.6% |
Data source: Social Security Administration, U.S. Labor Department.
As shown above, consumer prices increased 30.4% during the decade that ended in 2023, while Social Security COLAs increased benefits by just 28.6%. That means COLAs fell short of inflation by nearly 2 percentage points.
Put differently, the average annual increase in the CPI-W was 2.7% during the last decade, while the average annual COLA for Social Security benefits was 2.6%. That means COLAs trailed inflation by one-tenth of a percentage point per year.
Those differences may seem insignificant, but the discrepancies are more substantial in terms of dollars. The average retired worker received $1,264 per month in January 2013. COLAs would have increased that payout 28.6% to $1,626 per month in January 2023, but the average benefit (arguably) should have increased 30.4% to $1,648 per month. The difference is about $22 per month or $264 per year.
However, that only tells part of the story. Specifically, we can say the average retired worker would have received an extra $264 in 2023 if COLAs had matched the annual increases in CPI-W over the last decade. But what about the total lost income? If retired workers should have received an extra $264 in 2023, how much additional income should they have received during the past decade? The answer is $1,756.
In other words, if Social Security COLAs had tracked CPI-W inflation, the average retired worker would have received an additional $1,756 during the decade that ended in 2023. That sum is not enormous, but I doubt anyone would turn it down. Additionally, that flaw in the COLA calculation may explain why so many seniors are facing some degree of financial hardship.
