Author: Trevor Jennewine, The Motley Fool

Brisk inflation on the tail end of the pandemic led to a historic 8.7% cost-of-living adjustment (COLA) for Social Security benefits in 2023. Retired workers hadn’t received a pay raise that large in four decades. Yet, the 2023 Retirement Confidence Survey (RCS) conducted by the non-profit Employee Benefit Research Institute (EBRI) found that many retirees continued to struggle with financial hardship last year.

“The confidence both workers and retirees have in their ability to finance their retirements dropped significantly in 2023,” said Craig Copeland, EBRI Director of Wealth Benefits. “The last time a decline in confidence of this magnitude occurred was in 2008 during the global financial crisis.” The RCS also found that 58% of retirees expected to make significant spending cuts to keep pace with rising prices.

Adding to those concerns, Social Security benefits got a smaller 3.2% COLA this year, much to the dismay of many recipients. Indeed, 71% of retirees surveyed by The Senior Citizens League (TSCL), a non-profit senior advocacy group, said household costs have increased more than 3.2%, and 53% have already spent their emergency savings.

To that end, many retirees are probably hoping (and perhaps even expecting) a larger benefit increase next year. Unfortunately, the latest projection from TSCL shows Social Security’s COLA shrinking once again in 2025.

Why Social Security’s COLAs may have fallen behind inflation

Social Security’s cost-of-living-adjustments (COLAs) are based on the average inflation rate during the third quarter, the three-month period that includes July, August, and September. Curiously, COLAs are calculated using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a subset of the better-known CPU-U.

I call that curious because the CPI-W tracks price changes from the perspective of office workers and other employees that earn an hourly wage. But those individuals tend to spend money differently than Social Security recipients. For instance, workers may spend more on apparel and education, while retired workers tend to spend more on housing and healthcare. Some experts believe that discrepancy is why COLAs may have fallen behind inflation.

The calculation itself is straightforward: The third-quarter CPI-W from the current year is divided by the third-quarter CPI-W from the prior year, and the percent increase (if any) becomes the COLA in the following year. For instance, the CPI-W increased 3.2% in the third quarter of 2023, so Social Security benefits increased by 3.2% in 2024.

Social Security benefits are on pace for a 2.6% COLA in 2025

Inflation has definitely moderated since peaking in June 2022, but an unsettling trend has emerged in recent months. Rather than continuing to decelerate, consumer prices are once again building steam. Specifically, the CPI-W increased 2.9% in January, 3.1% in February, and 3.5% in March, the highest reading in seven months.

The March reading of 3.5% is particularly troubling because it tops the 3.2% COLA applied to Social Security benefits this year. That means benefits lost buying power last month because they increased less quickly than consumer prices. If that trend persists, beneficiaries may find themselves in an increasingly difficult financial position as the year drags on.

Despite that challenge, Social Security payments are on track to get a 2.6% COLA next year, according to The Senior Citizens League. That updated forecast tops the 1.8% COLA the group projected in February, but it falls short of the 3.2% COLA doled out in 2024. That is certainly an unpleasant surprise for many retired workers.

For context, the average retired-worker benefit was $1,910.79 per month in February 2024. Adding 2.6% to that figure brings the total to $1,960.47, meaning the average retiree would get about $49.68 more per month if Social Security benefits do indeed get a 2.6% COLA in 2025.

Of course, that figure is just an estimate. The Social Security Administration cannot determine the official COLA until third-quarter inflation data is available. That information is usually published in mid-October. In the meantime, retired workers should hope for the best but plan for worst. Meticulous budgeting and frugal spending are good places to start.

Additionally, it wouldn’t hurt to bring in some extra income. That could mean getting a part-time job, or simply moving money to a high-yield savings account, many of which look attractive given that interest rates have risen substantially.

The $22,924 Social Security bonus most retirees completely overlook

If you’re like most Americans, you’re a few years (or more) behind on your retirement savings. But a handful of little-known “Social Security secrets” could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $22,924 more… each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we’re all after.

Posted in Blog