In July, more than 51.2 million retirees brought home an average check of $1,919.40 from Social Security. The program, which was signed into law in August 1935 and sent its first check to retirees in January 1940, is vital to the financial well-being of most older Americans.

For 23 years, national pollster Gallup has surveyed retirees about their dependence on the income they receive from America’s top retirement program. Consistently, between 80% and 90% of retirees say they need their monthly benefit to cover at least some of their expenses.

For retirees, there’s nothing more important or anticipated than the unveiling of the annual cost-of-living adjustment (COLA), which is now less than seven weeks away (October 10, 2024). The exciting aspect of the Social Security 2025 COLA is that it’s on track to do something no one has seen this century. But at the same time, it’s still likely to leave retirees disappointed.

Image source: Getty Images.

What is the Social Security COLA and why is it important?

The Social Security cost of living adjustment is the mechanism by which benefits are adjusted almost annually to take account of price changes for a wide range of goods and services.

Imagine that the price of the goods and services you buy regularly increases by 5% from year to year. You want your income to increase by 5% to ensure that you can still buy the same amount of goods and services. The Social Security COLA is the instrument that adjusts benefits for inflation to ensure that purchasing power is not lost.

Between the first check for retired workers mailed in January 1940 and 1974, COLAs were entirely arbitrary and were passed by special sessions of Congress. After no COLAs for the entire 1940s, there were 11 adjustments from 1950 to 1974.

Beginning in 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) became the annual inflation index used to calculate the Social Security COLA. The CPI-W has more than a half-dozen major expenditure categories and a long list of subcategories, all of which have their own unique percentage weights. It is these specific weights that allow the CPI-W to be expressed as a single number at the end of each month, allowing for concise year-to-year comparisons to determine whether prices are rising (inflation) or falling (deflation).

Although the CPI-W is reported monthly, only the trailing 12-month measurements from July through September are used in the annual COLA calculation. If the average CPI-W measurement for the third quarter of the current year has increased relative to the average CPI-W measurement for the comparable period of the prior year, the collective price of goods and services has increased and beneficiaries should receive a cost-of-living adjustment in the coming year.

For the curious, the year-over-year percentage change in the third quarter (July-September) average CPI-W figures, rounded to the nearest tenth of a percent, determines how much benefits increase the following year (i.e., the COLA).

A sharp rise in the U.S. inflation rate has led to three consecutive years of above-average COLAs. U.S. inflation rate data from YCharts.

This would be a first this century for cost of living adjustment by social security

Since 2010, Social Security COLAs have been largely anemic. There have been 10 years where COLAs were 2% or lower, including the smallest positive COLA in history (0.3% in 2017) and three years where no COLA was reported due to deflation (2010, 2011 and 2016).

That trend has changed dramatically over the past three years, however. In 2022, 2023, and 2024, Social Security implemented cost-of-living adjustments of 5.9%, 8.7%, and 3.2%, respectively, all well above the 2.6% average COLA over the past 20 years. The 8.7% increase in benefits in 2023 was the largest in 41 years on a percentage basis.

Following the release of the July inflation report, the nonpartisan seniors advocacy group The Senior Citizens League (TSCL) updated its forecast for Social Security’s 2025 COLA to 2.57%, which is rounded to 2.6%. This is roughly in line with the 2.63% forecast following the June inflation report, and a mirror image of the 2.57% COLA forecast for 2025 following the May inflation report.

Meanwhile, independent Social Security and Medicare policy analyst Mary Johnson, who recently retired from TSCL, lowered her 2025 COLA forecast for the third month in a row. Johnson’s prediction that Social Security’s COLA will be 2.6% in 2025 is exactly in line with TSCL’s.

While a 2.6% COLA would be the smallest percentage increase in benefits in four years, it would be the first time this century that we’ve seen four consecutive years of COLAs of at least 2.6%. The last time that happened was 28 years ago.

For the more than 51 million retired workers receiving Social Security benefits, a 2.6% COLA next year would amount to an average monthly increase of about $50.

For comparison, the average monthly benefit in 2025 for disabled workers and survivors is expected to increase by about $40 and $39, respectively.

Image source: Getty Images.

Disappointment looms for pensioners

If Johnson and TSCL’s matching predictions of a 2.6% COLA in 2025 for Social Security hold true, it would mark the fourth year in a row that COLAs have met or exceeded the 20-year average. You’d think that would be good for retirees, but nothing could be further from the truth.

Although the CPI-W should ensure that the elderly do not lose purchasing power, the measure is performing dismally poorly.

As the full name of this inflationary tether implies, it is an index that focuses on the spending patterns of “urban wage earners and clerical workers.” Urban wage earners and clerical workers are primarily working-age Americans who are not currently receiving a Social Security check. More importantly, they spend their money differently than retirees.

Seniors spend a higher percentage of their monthly budget on housing and medical care than the average working American. However, the CPI-W does not place extra emphasis on these two categories of spending because it focuses on the spending patterns of younger Americans in general.

Based on the past 12 months, the inflation rate for housing (housing is the largest weighted component in the CPI-W) and medical care services is well above forecasts that predict a COLA of 2.6% in 2025. In other words, it suggests that the purchasing power of Social Security will decline further this year.

To make matters worse, most recipients risk having their COLA reduced or swallowed up entirely by a big jump in Medicare Part B premiums. This is the segment of Medicare that covers outpatient services.

In May, the Medicare Trustees Report estimated that Part B premiums would rise 5.9% to $185 per month in 2025. If Part B premiums more than double Social Security’s COLA, the impact of this 2.6% benefit increase would be limited.

Even though history is being made for the first time this century, pensioners are once again in for disappointment.