Inflation has cooled substantially since peaking in June 2022, but high prices are still a problem for many retired workers. A recent survey by the Employee Benefit Research Institute, a nonpartisan research organization, found that 56 percent of retirees are concerned that they will have to make big spending cuts to keep up with inflation.

Social security benefits will receive a 2.5% cost-of-living adjustment (COLA) in 2025 to offset rising prices across the economy. That’s the smallest increase for Social Security recipients since 2021, and most retired workers see the increase as insufficient, according to a recent survey hosted by The Motley Fool.

“The COLA increase is not substantial enough to overcome the rising costs facing Social Security recipients,” said Kevin Thomson, financial expert and CEO of 9i Capital Group. “This increase is likely to be overshadowed by rising shelter costs and medical expenses over the past year.”

Here are the important details.

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Social Security benefits get 2.5% cost-of-living adjustment (COLA) in 2025

Social insurance beneficiaries receive annually cost of living adjustments (COLA) to protect the purchasing power of benefits by ensuring that payments increase at the same rate as inflation. The value used to track inflation is a subset of Consumer price indexknown as the CPI-W, also called the Consumer Price Index for Urban Wage and Service Workers.

The calculation is simple: the average CPI-W value from the third quarter of the current year (ie, July to September) is divided by the equivalent reading from the previous year. The percentage increase then becomes COLA the following year. For example, the CPI-W increased by 2.5% in the third quarter of 2024, which means that Social Security benefits will receive a COLA of 2.5% in 2025.

That means the average retired worker will get an extra $49 a month, or $588 for the entire year, according to the Social Security Administration. Unfortunately, this pay increase comes with bad news: It may not accurately reflect the price pressures retirees face, in which case benefits would lose purchasing power next year.

Social security benefits may lose purchasing power in 2025

The CPI-W tracks inflation based on the purchasing habits of younger, working-age adults. Some experts see that as a problem because those people spend money differently than Social Security recipients. In other words, policy experts say it doesn’t make sense to calculate COLAs for retired workers based on how younger adults spend their money.

The biggest concern is that retired workers generally spend more on housing and health care and less on education and transportation compared to younger workers. But the CPI-W is weighted based on the spending patterns of younger adults, so it naturally understates the importance of housing and health care and overstates the importance of education and transportation.

The Senior Citizens League, a nonprofit advocacy group, estimates that the disconnect has caused Social Security to lose 20 percent of its purchasing power since 2010. And the problem is likely to get worse next year. While the global CPI-W rose by 2.5% in the third quarter of 2024, prices in undervalued expenditure categories (housing and healthcare) rose faster, while prices in overvalued categories (education and transport ) grew more slowly, as detailed below.

• Residence: 4.3%

• Medical care: 3.4%

• Education: 0.4%

• transport: (0.5%)

The Seniors League and several politicians have proposed calculating COLAs using another subset of the consumer price index called the CPI-E, or Consumer Price Index for Seniors. The CPI-E measures inflation based on the purchasing patterns of people age 62 and older, a group that more closely matches the portion of the population that collects Social Security benefits.

Importantly, CPI-E rose 3% during the third quarter of 2024, outpacing CPI-W by half a percentage point. In other words, Social Security recipients would have received a 3% COLA if the wage increase had been based on CPI-E inflation. In this scenario, the average retiree would have received $58 per month in 2025, or $696 for the entire year.

This means that the COLA applied to Social Security benefits in 2025 will arguably be too low, which is another way of saying that Social Security is about to lose purchasing power next year. While some politicians have proposed changing the CPI-E to the CPI-W, that change is unlikely to gain traction in Congress anytime soon. Social Security is already facing a multi-trillion dollar funding shortfall, and higher COLAs would make the problem worse.

On the bright side, retired workers looking for additional income next year have some good options. Interest rates are high, which makes deposit certificates (CDs) and high yield savings accounts attractive. And the stock market has hit all-time highs, making now a reasonable time to sell some stocks.

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