The January implementation of the 2025 Cost of Living Adjustment (COLA) for Social Security brought about a regrettable turn of events for retirees.
The January implementation of the 2025 Cost of Living Adjustment (COLA) for Social Security brought about a regrettable turn of events for retirees.
The 2.5% increase in Social Security benefits, due to the 2025 cost-of-living adjustment (COLA), commenced in January. This is the smallest increase for seniors since 2021, and over half of retirees, as per surveys conducted by Our Website, found the COLA inadequate.
However, the situation has worsened since then, as inflation has gained momentum post-COLA calculation. This implies negative consequences for Social Security beneficiaries in 2025.
The 2025 COLA might have underestimated inflation in 2024
Social Security's yearly COLAs aim to safeguard the purchasing power of benefit payments against inflation. In this context, inflation is gauged using a subset of the Consumer Price Index called the CPI-W, which represents the inflation rate for urban wage earners and clerical workers.
The process is straightforward: The CPI-W for the third quarter (July to September) of the current year is compared to the previous year's corresponding figure, and the percentage increase serves as the COLA for the subsequent year. For instance, the CPI-W rose 2.5% in the third quarter of 2024, hence, Social Security benefits saw a 2.5% increase in 2025.
Unfortunately, it's plausible that this number underestimates the actual inflation rate in 2024, ultimately reducing the benefits' purchasing power. This is attributable to the fact that CPI-W inflation has stepped up since the third quarter concluded. The CPI-W stood at 2.2% in September, but it jumped to 2.4% in October and 2.6% in November. Furthermore, the Federal Reserve Bank of Cleveland's predictive tool suggests that the trend continued into December.
The 2024 COLA might have underestimated inflation in 2023
The Senior Citizens League, a non-profit advocacy group, presumes that Social Security benefits' purchasing power depreciated by 20% between 2010 and 2024 due to inadequate COLAs. One reason for this is that CPI-W measures inflation based on the spending habits of working-age adults. However, their spending patterns diverge significantly from those of retired workers.
Another contributing factor is that COLAs are derived by extrapolating third-quarter CPI-W data to an annual figure. For example, CPI-W inflation rose 3.2% in the third quarter of 2023, resulting in a 3.2% COLA in 2024. But the full-year CPI-W increase was 3.8% in 2023. Consequently, the COLA failed to account for inflation by 0.6 percentage points. As a result, the benefits lost purchasing power.
This issue resurfaced in 2024. The average monthly CPI-W reading surged 2.9% through November, although this figure may climb following the December reading's publication later this month. This indicates that the 2.5% COLA in 2025 may have underestimated inflation in 2024 by at least 0.4 percentage points. Consequently, the benefits lost purchasing power once again.
It's crucial to note that we're not discussing substantial monetary increments here. The average Social Security benefit for retirees is predicted to enhance by $49 per month following the 2.5% COLA in 2025. However, the average benefit would have increased by around $56 per month had the 2025 COLA been 2.9%. This translates to an average deficit of less than $100 for retirees during the entire year.
Unfortunately, the issue escalates over time. A retiree with average benefits in 2023 would have received an additional $19 per month in 2025 if the previous two COLAs were calculated based on the full-year CPI-W rather than the third-quarter reading. For these beneficiaries, the shortfall will exceed $200 this year. This amounts to a more substantial loss in purchasing power.
Despite the challenges, retirees can potentially offset any Social Security benefit shortfall by leveraging increased interest rates to earn additional income in 2025. Several financial institutions provide competitive rates on Certificates of Deposit (CDs) and high-yield savings accounts.
In light of the increasing inflation rates after the COLA calculation in 2024, there's a concern that the 2025 COLA might have underestimated inflation, potentially affecting the purchasing power of Social Security benefits for retirees.
The estimate by The Senior Citizens League suggests that inadequate COLAs led to a depreciation of 20% in Social Security benefits' purchasing power between 2010 and 2024, partially due to the third-quarter CPI-W data being used to determine the COLA, which may not fully capture inflation during the entire year.