The potential history in the creation of Social Security may once again come to the detriment of the program’s retirees.
In May, more than 51 million retiree beneficiaries took home an average Social Security check of $1,916.63, which works out to roughly $23,000 on an annualized basis. Although America’s flagship retirement program won’t make its recipients rich, the income it provides helps build a financial foundation for most seniors.
In April, the national Gallup poll polled retirees to rate how necessary their Social Security income is to make ends meet. A whopping 88% of respondents indicated that their Social Security payment represents either a “large” or “small” source of income. In fact, more than two decades of annual polls by Gallup have shown that 80% to 90% of retirees would struggle to meet their expenses without Social Security.
With roughly nine out of 10 retirees depending on their Social Security check in some capacity, it should come as no surprise that the cost-of-living adjustment (COLA) revealed during the second week of October is the most eagerly awaited announcement each year.
Image source: Getty Images.
What purpose does the Social Security COLA serve and how is it calculated?
As you’ve probably noticed, the prices of the goods and services you buy regularly fluctuate. They can increase (known as inflation) or decrease (deflation) over time. What Social Security’s COLA is supposed to do is account for price changes in a broad basket of goods and services and ensure that those changes are reflected in the income that beneficiaries receive.
In simpler terms, if the price of a basket of goods and services that seniors regularly purchase increases from year to year, Social Security checks should ideally increase by the same percentage to ensure that beneficiaries do not lose out. no purchasing power.
Before 1975, there was no rhyme or reason to cost-of-living adjustments. They were arbitrarily adopted by special sessions of Congress, with zero adjustments made throughout the 1940s.
Beginning in 1975, the Consumer Price Index for Urban Wage and Clerical Workers (CPI-W) became the permanent inflation measure used by Social Security to calculate annual COLAs. The CPI-W has eight main expenditure categories and countless subcategories, all of which have their own unique weights.
These individual weightings are what allow the CPI-W to be broken down into a single figure each month, which can then be easily compared to previous months or years to determine whether inflation or deflation has occurred.
Calculating the Social Security cost of living adjustment is really simple. The 12-month average reading of the CPI-W from the third quarter of the current year (only readings from July through September are used in the COLA calculation) is compared to the average reading of the CPI-W from the third quarter of last year. . If the average reading rises, inflation has occurred and beneficiaries will have a larger benefit in the following year.
For those curious, the percentage difference in the average third quarter CPI-W reading from one year to the next, rounded to the nearest tenth of a percent, determines the next year’s COLA.
Above-average inflation has raised COLAs over the past three years. US inflation data according to YCharts.
Social Security’s cost-of-living adjustment last did so in 1993
While we don’t yet have any of the CPI-W readings that count toward the 2025 COLA calculation, the year-over-year CPI-W readings through May 2024 provide great clues about what’s to come. In particular, the CPI-W readings suggest that Social Security’s COLA is on pace to do something no one has seen since 1993.
In mid-June, the US Bureau of Labor Statistics released its May inflation report, which showed that the CPI-W had risen 3.3% on a trailing 12-month basis. This was one-tenth of a percentage point from 3.4% in the April inflation report. (Note: This article was written before the June inflation report was released on July 11.)
While the headline rate of inflation moderated less and less in May, at least one estimate still suggests that Social Security’s cost-of-living adjustment could make history in 2025.
According to independent Social Security and Medicare policy analyst Mary Johnson — who previously worked for the senior nonpartisan advocacy group The Senior Citizens League before her recent retirement — the 2025 COLA is on track to reached 3%.
Based on Social Security COLA data over the past two decades, a 3% cost-of-living adjustment is a pretty big deal. Since 2010, there have been three years without a COLA (2010, 2011, and 2016), along with another year that went by the smallest COLA on record (0.3% in 2017).
But over the past three years, Social Security’s cost-of-living adjustments have run well above the two-decade average of 2.6%. In 2022, 2023 and 2024, beneficiaries saw their checks increase by 5.9%, 8.7% and 3.2%, respectively. The 8.7% increase last year was the largest since 1982 and the largest nominal dollar increase in Social Security checks since the program began.
Where things get “historic” is if Johnson’s 3% COLA estimate turns out to be correct. If so, it would be the first time in 32 years that four consecutive COLAs have reached at least 3% (COLAs from 1988 to 1993 ranged from 3% to 5.4%).
In dollar terms, a 3% cost-of-living adjustment would increase the average retired worker’s benefit by about $57 per month in 2025. Meanwhile, disabled workers and survivor beneficiaries would see their benefits increase. their monthly with an average of 46 dollars and 45 dollars, respectively.
Image source: Getty Images.
Pensioners continue to get the short end of the stick
On paper, you’d think four straight years of above-average COLAs would have retirees sitting pretty — but that couldn’t be further from the truth.
In May of last year, when The Senior Citizens League released its 2024 COLA guidance, it also released a study that compared cumulative COLAs since the start of the 21st century to price changes in a large basket of goods and services purchased regularly by the elderly. While total COLAs between January 2000 and February 2023 increased benefits by 78%, dozens of goods and services that retirees typically purchase collectively increased in price by 141.4%.
The bottom line of the League of Senior Citizens analysis is that Social Security revenues have lost 36% of their purchasing power since the beginning of this century.
The bigger issue is that the factors responsible for supporting the prevailing rate of inflation are the expenses that matter most to the elderly. Compared to the average working American, seniors spend a significantly higher percentage of their monthly budget on housing and medical care.
Shelter has the largest weight in the CPI-W of any category. With the Federal Reserve embarking on its most aggressive rate hike cycle in four decades, mortgage rates have risen and existing home sales have stalled. Not surprisingly, rental inflation has remained stubbornly high, which has provided a boost to the CPI-W.
In recent months, we have witnessed an increase in the inflation rate for medical services.
Even if Social Security’s cost-of-living adjustment for 2025 is 3%, or slightly higher than Johnson’s estimate, it’s unlikely to represent a big enough “boost” to offset the inflation retirees are currently facing . In short, retirees are bound to get the short end of the stick, once again, in 2025.