Social Security’s cost-of-living adjustment (COLA) mechanism, designed to safeguard the buying power of benefits against inflation, faces challenges as inflation trends upward. The COLA for 2025, based on inflation data from the third quarter of 2024, may not be sufficient to fully counteract rising costs, leaving retirees with reduced purchasing power.
How Cola Protects Social Security Benefits
Since 1975, COLA adjustments have been calculated using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The process compares CPI-W data from the third quarter of one year to the same period of the previous year. The percentage increase determines the COLA, which is applied to Social Security benefits the following year. This system ensures benefits increase in line with inflation.
For instance, a 2.5% COLA was applied to Social Security payments in 2025, reflecting CPI-W inflation from the third quarter of 2024. However, inflation’s recent acceleration poses significant challenges.
Rising Inflation Reduces Social Security’s Spending Power
Inflation has been on an upward trajectory since late 2024. After falling to 2.2% in September 2024, CPI-W inflation increased to 2.4% in October, 2.6% in November, and 2.8% in December. As a result, the 2.5% COLA for 2025 underestimated the full-year CPI-W inflation of 2.9%, causing a 0.4% shortfall in benefits.
This shortfall follows a similar pattern in 2024, when a 3.2% COLA failed to match 3.8% inflation in 2023. Over two years, the cumulative shortfall has left retirees receiving 5.8% more in benefits rather than the 6.8% needed to keep pace with inflation. For a retiree receiving the average $1,905 per month in 2023, the cumulative discrepancy results in $228 less income annually.
While these imbalances often correct over time during periods of low inflation, the current rise in inflation suggests Social Security benefits may continue to lose purchasing power in 2025.
Options for Retirees to Offset Reduced Benefits
Retirees looking to counter diminished purchasing power have several strategies to supplement income:
- Stock Market Gains: With the S&P 500 near record highs, selling stocks could provide additional funds.
- High-Yield Savings Accounts: Elevated interest rates have made these accounts attractive, offering competitive returns.
- Money Market Funds: Options like the Vanguard Federal Money Market Fund (VMFXX) provide monthly dividend payouts and have returned 5.1% in the past year. These funds may continue offering similar yields in 2025, especially if the Federal Reserve maintains current interest rates.
The rise in inflation highlights the inherent lag in COLA calculations and its impact on retirees’ financial well-being. While the COLA system provides essential support, persistent inflation underscores the need for retirees to explore additional income sources to safeguard their financial stability.
Got a reaction? Share your thoughts in the comments
Enjoyed this article? Subscribe to our free Newsletter for captivating articles, exclusive content, and the latest news.
