Social Security's 2025 cost of living adjustment (COLA) is becoming a double-edged sword for retirees

For most retired Americans, Social Security provides more than just a monthly check. The income they receive provides a financial foundation for their golden years.

For the past 23 years, national pollster Gallup has surveyed retirees to determine how much they rely on America's leading social program. Across the board, between 80 and 90% of respondents said they need their Social Security check to cover at least some of their expenses, including 88% of respondents in April 2024.

With so many aging Americans counting on Social Security to shore up their finances, it should come as no surprise that the annual cost of living adjustment (COLA) is the most anticipated revelation of the year. That revelation is now less than two weeks away.

While there is a glimmer of hope for beneficiaries, Social Security's 2025 COLA appears to be proving to be a double-edged sword for retirees.

What is Social Security COLA and how is it determined?

The Social Security cost-of-living adjustment you keep hearing about is the “increase” that beneficiaries receive most years to offset rising prices—what's better known as inflation. You'll notice that I put “increase” in quotes to make it clear that increases in Social Security benefits are intended to match inflation, not exceed it, which might be possible with a real increase from an employer.

Hypothetically, if the price of a broad basket of goods and services that retirees regularly purchase increases by 3.5% from year to year, Social Security benefits should increase by the same percentage to ensure that the same amount of goods and services are available continued to buy. COLA is effectively the mechanism the Social Security Administration uses to prevent beneficiaries from losing purchasing power.

In the 35 years following the first mailed check to retired workers (January 1940 to December 1974), there was no rhyme or reason for these adjustments. There were no changes to benefits during the entire 1940s, and only 11 COLAs were passed by special sessions of Congress in the other 25 years.

Beginning in 1975, the Consumer Price Index for Urban Wage Earners and Office Workers (CPI-W) became the program's inflation measure responsible for determining annual COLAs yearly Base. Each component of the CPI-W has individual percentage weights that allow the index to be reduced to a single number each month, allowing incredibly easy year-to-year comparisons to determine whether prices overall are rising (inflation) or declining (Deflation).

Although the U.S. Bureau of Labor Statistics reports the CPI-W monthly, the COLA calculation only considers values ​​from the last 12 months ending in July, August, and September (i.e., the third quarter). If the average CPI-W value in the third quarter of the current year is higher than in the comparable period of the previous year, prices have increased and beneficiaries must receive a “raise” in the coming year.

The percentage difference in these third-quarter average CPI-W values ​​from the previous year, rounded to the nearest tenth of a percent, determines the amount of Social Security's COLA for the following year.

A significant increase in the prevailing inflation rate resulted in outsized COLAs in 2022, 2023 and 2024. US inflation rate data from YCharts.

Social Security's cost of living adjustment through 2025 offers a modest bright spot

For most of the past 15 years, Social Security COLAs have been tiny. Two-thirds of COLAs were 2% or less, including three years in which deflation occurred and no COLA was passed (2010, 2011, and 2016).

However, when the central bank and federal government flooded the U.S. economy with capital during the COVID-19 pandemic, we experienced one gigantic Increase in the prevailing inflation rate and subsequent cost of living adjustments by Social Security over the last three years: 5.9% in 2022, 8.7% in 2023 and 3.2% in 2024.

Despite the prevailing slowdown in U.S. inflation this year, beneficiaries are on track to receive an above-average COLA compared to the last 15 years.

The nonpartisan senior advocacy group The Senior Citizens League (TSCL) earlier this year forecast a paltry 1.4% COLA for 2025. But after August's inflation report, its policy analysts have settled on an estimate of a 2.5% COLA for that agreed next year.

By comparison, independent Social Security and Medicare policy analyst Mary Johnson, who recently retired from TSCL, started her 2025 COLA estimate at 3.2% and has raised her forecast to, you guessed it, 2.5% lowered!

With the prevailing inflation rate at its lowest level since February 2021, there is hope that some of the price pressures weighing on retirees will ease. At the same time, maintaining an above-average COLA over the past 15 years is a silver lining.

For the average retired beneficiary, a 2.5% cost of living adjustment represents a monthly increase of about $48. Meanwhile, workers with disabilities and survivors can expect increases of about $39 per month and $38 per month, respectively.

Image source: Getty Images.

Social Security's 2025 COLA is another double-edged sword for retirees

On the surface, a fourth straight year of significant nominal increases in monthly benefit checks looks great. But if retirees dig a little deeper, they'll find they're losing out in many ways.

For example, even though the prevailing inflation rate is at its lowest level in more than three years, the costs that matter most to Americans in retirement show no signs of easing. Compared to the typical working American, seniors spend a disproportionately higher percentage of their budgets on housing and medical care.

Based on the last 12 months, the Consumer Price Index for All Urban Consumers (CPI-U), a similar measure of inflation to the CPI-W, shows inflation of 5.2% for housing and medical care services and 3.2%, respectively. As long as these two important retiree expenses exceed the projected COLA for 2025, retirees can almost certainly expect a loss of purchasing power.

Unfortunately, a loss of purchasing power has been the order of the day for some time. TSCL recently released a report estimating that the purchasing power of a Social Security dollar for seniors has declined 20% since the start of 2010. Next year's COLA is unlikely to change that dynamic.

Additionally, the Medicare Trustees Report released in May estimates that the Part B premium is expected to rise 5.9% to $185 per month in 2025. Part B is the arm of Medicare responsible for outpatient services, and this would be a 5.9% increase for the second year in a row.

Most Social Security recipients have their Part B payment automatically deducted from their monthly check. Because the Part B premium increase is expected to more than double the projected COLA of 2.5%, the majority of beneficiaries can expect the “increase” to be partially or completely eliminated next year.

Although there are possible glimmers of hope, Social Security's 2025 COLA is shaping up to be a double-edged sword for retirees.