The Imperfection in the Method for Determining Social Security Benefits Results in an Average Loss of $120 for Retirees in 2025
The Imperfection in the Method for Determining Social Security Benefits Results in an Average Loss of $120 for Retirees in 2025
Soon, retirees will start receiving their initial Social Security benefits with the 2025 cost-of-living adjustment (COLA) included. This adjustment will boost the average monthly payout to $1,976. Despite expectations, this increase falls short of what many hoped for, particularly after three years of above-average COLAs, such as the impressive 8.7% hike in 2023.
Many people contend that the 2.5% increase won't be enough to offset the increasing expenses seniors will face in 2025. An unusual aspect of Social Security benefit computation may be to blame for this shortfall. Predictions suggest that an average retiree may need to spend an extra $120 in 2026, and some may even miss out on more.
Understanding COLA Computation
The Social Security Administration (SSA) typically applies COLAs in most years to help Social Security benefits keep pace with inflation. The SSA calculates inflation using the variations in the third-quarter averages of the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from one year to the next.
By calculating the CPI-W numbers for July, August, and September of the current year, summing them up, and then dividing by three to acquire the third-quarter average, the government compares this to the average of the same months in the previous year. The difference yields the COLA. In 2025, the 2024 average was 2.5% greater than the 2023 average, resulting in a 2.5% COLA for 2025.
However, this method appears logical until one learns that the CPI-W focuses on the spending habits of households in urban areas where at least one member was employed for at least 37 weeks per year, or where at least 50% of household income originates from eligible wage-associated jobs. Consequently, retirees without jobs are not factored into this index.
Instead, retirees are tracked by a separate index called the Consumer Price Index for the Elderly (CPI-E). This index focuses on the spending habits of individuals aged 62 and above, as these habits often deviate from their younger counterparts. For example, older adults usually spend more on medical care than younger adults, but they may spend less in other areas.
The Impact of the COLA Calculation on Retirees
Critics argue that the government should use the CPI-E to calculate Social Security COLAs instead of the CPI-W because the CPI-E better represents retiree spending habits. Implementing this change would result in larger COLAs in most years.
The Senior Citizens League (TSCL), a nonpartisan senior advocacy group, discovered that utilization of the CPI-E instead of the CPI-W would have resulted in higher COLAs in seven of the ten years between 2014 and 2024. Had this adjustment been in place, retirees would have received an additional $2,689 over that decade.
Retirees may face the same dilemma in 2025. If the government had utilized the CPI-E to determine the COLA, seniors would be receiving a 3% increase to their checks instead of 2.5%. This would have added another $10 to the average monthly benefit.
Although this increase may seem insignificant, it would provide the average retiree with an additional $120 to spend in 2025, which is nearly enough to cover the expected increase in the Medicare Part B premium, which is usually deducted automatically from Social Security benefits for those enrolled in both programs.
The Future of COLA Calculation
Although there are currently no plans to alter the COLA calculation to utilize the CPI-E instead of the CPI-W, this doesn't mean it will never happen. Some members of Congress support this proposal, but it has yet to generate enough support. If it does, this change is likely to occur as part of broader Social Security reforms aimed at addressing Social Security's impending shortfall.
In the interim, retirees may need to supplement their Social Security checks with personal savings or income from a job to cover expenses that their benefits do not cover. Additionally, one can investigate whether they are eligible for other government benefits, such as Supplemental Security Income (SSI), to help make ends meet.
Given the current method of calculating COLAs using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which primarily considers urban workers' spending habits, many retirees have voiced concerns that this approach does not adequately reflect their increased costs, particularly in terms of healthcare. As a result, organizations like the Senior Citizens League (TSCL) advocate for the use of the Consumer Price Index for the Elderly (CPI-E), which focuses on elderly individuals' spending habits, arguing that this would result in larger COLAs and provide retirees with more financial stability during retirement. Moreover, as retirees manage their retirement finances, exploring options for additional income sources, such as Supplemental Security Income (SSI), can help bridge any income gaps.