Social Security’s 2025 Cost of Living Adjustments (COLA) are expected to be a good news/bad news situation.

As of January, more than 50 million retired workers were taking home Social Security benefits averaging $1,909 per month. Social Security checks may not make retirees rich, but they help lift more than 15 million people age 65 and older out of poverty each year.

Moreover, the overwhelming majority of retirees rely on monthly payments to make ends meet. An annual survey conducted by national pollster Gallup for more than 20 years found that 80 to 90 percent of retirees at that time needed some Social Security benefits to cover costs.

Considering how important Social Security is to the financial foundations of older Americans, perhaps no event is more anticipated each year than the cost-of-living adjustments (COLAs) announced by the Social Security Administration (SSA).

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What is Social Security’s COLA and how is it calculated?

Social Security’s cost-of-living adjustments are best thought of as a tool used by SSA to ensure beneficiaries don’t lose purchasing power due to inflation. That means, if the price of the basket of goods and services you typically buy increases, then in an ideal world your Social Security checks should also increase by the same percentage, ensuring that beneficiaries can continue to buy the same goods and services. COLA is a mechanism designed to make this happen.

Before 1975, Social Security’s COLAs were passed arbitrarily in special sessions of Congress. In fact, beneficiaries spent the entire decade of the 1940s before the first COLA was passed in 1950. Since 1975, the program’s COLA has been calculated annually using the Consumer Price Index for Urban Wage and White Collar Workers (CPI-W).

The beauty of CPI-W is that it has eight main spending categories and numerous subcategories, all with their own weights. The advantage of anything having specific weights is that you can reduce CPI-W to a single number each month. large in size The basket of products and services is very simple.

What’s unique about Social Security’s COLA calculation is that it only considers CPI-W numbers from the third quarter (Q3). That means from July to September. The U.S. Bureau of Labor Statistics (BLS) reports for the remaining nine months of the year, but this does not affect the COLA calculation.

If the average CPI-W number for the third quarter of this year is higher than the average CPI-W number for the third quarter of the previous year, inflation has occurred and beneficiaries will receive larger payments the following year. The benefit increase amount is simply the percentage difference from the previous year in the average third quarter CPI-W reading, rounded to the nearest tenth of one percent.

High inflation rates have caused Social Security’s COLA to increase for three consecutive years. US inflation rate data from YCharts.

There may be hope in Social Security’s 2025 cost-of-living adjustments

As you can see, we are still quite far from the time period that actually matters for Social Security’s COLA calculations. Nonetheless, the months not included in the calculation may provide a clue as to what the beneficiary can expect in the following year.

The December inflation report released by the BLS in mid-January offers potential hope for all 67 million-plus Social Security recipients.

Although the aggregate inflation rate has been decreasing since June 2022, important components of the CPI-W and the Consumer Price Index for All Urban Consumers (CPI-U) remain high. In December, the unadjusted 12-month inflation rate for shelters was very high at 6.2% CPI-U. CPI-U is a similar measure of inflation to CPI-W, and shelter is the cost category with the highest weight in both indices.

The Federal Reserve’s most aggressive rate hike cycle in over 40 years has caused mortgage rates to soar after a period of historically low lending rates. As a result, the number of existing homes on the market has decreased and the power of landlords to set rental prices has increased significantly. As long as shelter prices continue to rise, I believe Social Security’s 2025 COLA will likely be higher than the 2.6% average over the past 20 years.

For what it’s worth, CPI-W is up 3.3% over the past 12 months (as of December 2023). Hypothetically, if Social Security’s 2025 cost-of-living adjustments are confirmed at about 3% during the third quarter, the average retiree-to-worker benefit would see an increase of nearly $60 per month in the coming year.

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There’s also potential bad news

It followed a period of poor cost-of-living adjustments from 2010 to 2021, with no COLAs delivered for three years, and a fourth straight year with pay checks coming in at just 0.3%, the fourth consecutive year above average. COLA in 2025 will be a welcome sight. Unfortunately, we cannot be free from negative influences.

While historically high shelter inflation is a factor that could drive the program’s COLA in 2025, shelter is one of two major expenses (the other being health care) that accounts for a higher percentage of monthly spending for seniors than for working-age Americans. In other words, if the rate of inflation for shelters remains high, the purchasing power of retired workers is expected to decline, even if the 2025 COLA is higher than the average over the past 20 years.

The inconvenient reality for seniors is that the purchasing power of Social Security dollars has been plummeting since the turn of the century.

In May 2023, the Senior Citizens League (TSCL), a nonpartisan senior advocacy group, published a study examining this ongoing loss of purchasing power. From January 2000 to February 2023, total cost-of-living adjustments increased 78%, while the cost of a typical basket of goods and services purchased by the average retiree increased 141.4% over the same period. The purchasing power of seniors’ Social Security income has fallen 36% since 2000, according to TSCL.

The cause of this steady erosion is CPI-W. As its full name suggests, it is an index that focuses on the consumption habits of ‘urban workers and office workers.’ These are primarily working-age Americans, and few of them are currently receiving Social Security benefits.

Meanwhile, more than 80% of existing beneficiaries are over 62 years old. Older people spend their money very differently than working-age Americans. As a result, CPI-W does not adequately consider the costs that matter most to retired workers, such as shelter and health care.

Lawmakers on both sides of politics agree that the CPI-W is not doing a particularly good job, but finding a solution has been difficult. Both Democrats and Republicans have proposed workable solutions, but their respective inflation measures come from opposite ends of the spectrum. With bipartisan cooperation on Social Security virtually non-existent in Congress, there is little hope of reducing this loss of purchasing power any time soon.