There's a Big Problem With the 2025 Social Security COLA

If you receive Social Security retirement benefits, more money should be coming your way this month. In October, the Social Security Administration (SSA) announced a 2.5% cost-of-living adjustment (COLA). This benefit increase became effective on Jan. 1, 2025.

However, retirees probably shouldn't celebrate too much. There's a big problem with the 2025 Social Security COLA.

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What's the big problem?

Anyone who has been collecting Social Security benefits for a few years knows that the 2025 COLA is smaller than what they have grown accustomed to receiving. The 2.5% increase is well below the 3.2% bump received last year and only a fraction of the 2023 COLA of 8.7%. However, this isn't the big problem.

The real issue with the 2025 Social Security COLA is simply that it won't be enough for many retirees. And the majority of retirees are concerned about it.

The nonprofit seniors advocacy organization The Senior Citizens League surveyed 3,000 older Americans a few months ago. Roughly 70% of them expressed worries that high inflation would cause them to potentially deplete their retirement savings despite receiving increased Social Security benefits.

Recent inflation data appear to justify those concerns. The Consumer Price Index (CPI) -- often referred to as the "headline" inflation number -- jumped 2.6% year over year, higher than the 2025 COLA. So did the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), the inflation metric used to calculate the COLA.

Even worse, the costs of some items that affect many retirees more than most other Americans increased at much higher rates. For example, the cost of eating out rose 3.6% in November. Medical care services jumped 3.7%. The latter is especially worrisome because seniors typically spend much more on healthcare than younger individuals do.

The root cause of the problem

Social Security COLAs are intended to offset the erosion of benefits caused by inflation. So why don't they achieve this goal? The root cause of the problem is how they are calculated.

As previously mentioned, the SSA uses the CPI-W to determine the amount of the annual benefits increase (if any). Specifically, the agency compares the average CPI-W for the third quarter of the year against the average for the previous year. The COLA is set at the percentage difference between these averages, rounded to the nearest one-tenth of 1%. If the average is the same or lower than the third-quarter average for the previous year, no adjustment is given.

The primary issue is the CPI-W itself. It often underestimates how much inflation negatively affects seniors. This is due to the weights the index gives to expenses such as healthcare that tend to impact seniors more.

The Senior Citizens League conducted a study that determined retirees' Social Security benefits have lost over 30% of their buying power since 2000 because of the inherent flaw with the CPI-W. This analysis underscores that the big problem with the 2025 Social Security COLA isn't a new one.

Is there a solution?

Retirees could hope and pray that inflation in 2025 turns out to be lower than the 2.5% COLA received for this year. Some might be able to stretch their money as much as possible to help make ends meet. Neither is an ideal solution, though.

The good news is that the big problem with the 2025 Social Security COLA (and the calculation process itself) could be largely resolved with a simple change. Replacing the CPI-W with another inflation metric -- the Consumer Price Index for the Elderly (CPI-E) -- would go a long way toward ensuring that annual COLAs keep up with the higher prices incurred by retirees.

For example, this year's COLA would be 3% instead of 2.5% if the CPI-E were used rather than the CPI-W. Since 2015, the annual COLA using the CPI-W has averaged 2.8%. Replacing the metric with the CPI-E would have increased the average COLA to 3%.

An even better approach would be to use the higher of the CPI-E and CPI-W to calculate the COLA. Using this method would have bumped the average COLA since 2015 to 3.2%.

Now for the bad news: The prospects for changing the COLA calculation to use the CPI-E aren't great right now. Previous attempts to pass Social Security reforms that incorporate the alternative inflation metric haven't succeeded.

One challenge with replacing the CPI-W with the CPI-E is that it would likely increase Social Security's cash outflows. This highlights an even bigger problem for the program -- it's running out of money -- than the COLA calculation method.

There's good news and bad news on this front, too. Potential solutions have been identified that would prevent future benefit cuts, but none of them have gained enough support on Capitol Hill to be enacted.

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