This is how high Social Security's COLA should be in 2025 to keep pace with inflation

Social Security cost-of-living adjustments (COLAs) are changes made to reflect the rate of inflation in Social Security benefits and to ensure that those benefits “are not eroded by inflation,” according to the Social Security Administration (SSA).

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However, some experts argue that these changes are not keeping pace with real price developments, which in turn raises concerns about the financial situation of retirees, many of whom rely on these benefits in their golden years.

So how high should the COLA be in 2025 to keep pace with inflation?

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How is the COLA calculated?

First, it is important to note that these COLA adjustments are based on a sub-index of the Consumer Price Index (CPI), which is released monthly and is a measure of consumer inflation.

The intention, according to the SSA, is to use changes in this sub-index – the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) – so that “inflation no longer erodes the value of Social Security benefits.”

For 2024, the SSA has set a COLA of 3.2%. The next COLA will be announced in October 2024, and it will be applied to 2025 benefits. To put this in perspective, in 2022 it announced a COLA of 8.7%—the highest since 1981, according to SSA data reflecting high inflation at the time.

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Is this an accurate measurement?

However, many experts argue that this is not an appropriate measure for measuring inflation changes related to Social Security benefits – and that it would significantly harm those benefits.

For example, Martha Shedden, president and co-founder of the National Association of Registered Social Security Analysts, called the use of the CPI-W an “unrealistic representation of what retirees spend their money on.”

She explained that there are efforts to use another index instead, namely the Consumer Price Index for Older Persons (CPI-E), which is intended to more accurately reflect the spending habits of households with people aged 62 and over.

“Both indicators use the same formulas and prices, but their meaning is determined differently,” she said, noting that the CPI-E indicator is smaller, leading to larger sampling errors.

“So it's not really known how much the CPI-E would change the annual COLA,” she added.

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Advocacy groups have been pushing for a change for some time. The National Committee to Preserve Social Security and Medicare, for example, said the CPI-E has been “under review for four decades” and that the government should adopt it to reflect “a more accurate consumer price index for the elderly.”

What is the projected COLA for 2025?

According to an August 14 statement from the Senior Citizens League (TSCL), the COLA in 2025 will be significantly lower than the current adjustment of 3.2%. The projected COLA is 2.57%, below the 2.63% expectation in July.

In fact, inflation fell to 2.9% in July from 3% in June – the first time it has been below 3% since March 2021, according to the latest consumer price index released on August 14.

But while falling inflation is good news for consumers, in this case it is not good news for seniors.

TSCL said in the statement that 75 percent of seniors wanted Congress to base the COLA on the CPI-E, “a price index specifically tailored to seniors, rather than the CPI for urban wage earners (CPI-W), which is more appropriate for the general population.”

A separate report even added that without an accurate COLA, “beneficiaries will lose purchasing power.”

To make up for this loss, the company estimates that benefits would have to be higher by $370.23 per month or $4,442.80 per year.

How high should the COLA be in 2025 to keep pace with inflation?

According to Thomas Savidge, an economist at the American Institute for Economic Research, “Social Security will need to make significant changes to keep pace with inflation.”

In his view, the COLA should be a flat benefit indexed to inflation and not tied to taxable income and retirement age.

“To offset the lump sum benefits, Americans should be allowed to invest a portion of their Social Security contributions in a private retirement account, which often yields a higher return on investment than Social Security,” he said.

According to experts, the question of how high the interest rate should be in 2025 to keep pace with inflation is difficult to determine exactly.

However, using the CPI-E might be a better option because it focuses on inflation for people ages 62 and older.

“The CPI-E was introduced in 2008 and is released monthly along with other inflation data. While it is not always higher, using it for the 2024 COLA would have resulted in a 0.8% higher increase than the standard method,” said Devin Carroll, owner and senior adviser at Carroll Advisory Group.

He said that if current trends continue, the COLA would be about 0.3% higher in 2025 compared to the CPI-E.

“Using the CPI-E would make the COLA for seniors more realistic because it better reflects the costs they face,” he added. “In 2025, this could bring the COLA to about 3%.”

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This article originally appeared on GOBankingRates.com: I'm an Economist: Here's How High Social Security's COLA Should Be in 2025 to Keep Pace with Inflation