Social Security's COLA forecast for 2025 was just updated. There's good news and bad news.

Welfare recipients receive an annual cost-of-living adjustment (COLA) to protect the purchasing power of their benefits from inflation. Still, many retirees struggle to keep up with rising prices. More than two-thirds of Welfare recipients surveyed by the Senior Citizens League said the 3.2% COLA applied to payments this year is not enough to offset the increase in their household costs.

The latest data from the Labor Department shows inflation cooled to a three-year low in August. That information was released this week and led to a downward revision to the 2025 COLA forecast. Read on to learn why the latest forecast spells both good and bad news for retirees collecting Social Security benefits.

The good news: The downward revision of the COLA forecast means that inflation is cooling rapidly

The Senior Citizens League (TSCL) is one of the largest nonpartisan senior advocacy groups in the United States. Following August inflation data, TSCL revised its forecast for the Social Security cost-of-living adjustment (COLA) in 2025 downward to 2.5% (previously it was 2.6%). Either way, retirees and other benefit recipients are on track for the lowest COLA since 2021.

A lower COLA may not sound like great news, but it means inflation is easing—and that's a positive development. COLAs are designed to reimburse Social Security recipients for purchasing power benefits lost in the previous year. As a result, recipients are constantly behind, but the financial burden is especially great when inflation is trending upward.

You can think of it this way: Inflation reduces the value of money. If inflation increases each month, money will devalue faster and faster. But if inflation decreases each month, money will devalue more and more slowly. In the second scenario, the burden is easier to bear, so declining inflation is good news for Social Security recipients, even if it means a lower COLA in 2025.

The bad news: Social benefits could lose purchasing power in 2025

Social Security's annual COLAs are based on the CPI-W, a subset of the Consumer Price Index (CPI) that measures inflation based on the spending patterns of office workers and hourly wage earners. The CPI-W includes eight broad spending categories that are weighted based on the typical behavior of the target population.

Calculating COLAs using the CPI-W is problematic because workers tend to spend their money differently than retirees who receive Social Security benefits. For example, retirees generally spend more on housing and healthcare and less on transportation and education. The CPI-W does not account for these differences and therefore underemphasizes certain categories of spending and overemphasizes others.

Many experts believe Social Security COLAs should be tied to the CPI-E, a part of the Consumer Price Index that measures inflation based on the spending patterns of people age 62 and older. This demographic overlaps more with retirees, so the index should be a more accurate indicator of inflation for these people.

Here's the bad news: CPI-E inflation will exceed CPI-W inflation for the first eight months of 2024. And the gap between the two measures widened in August because CPI-E inflation is cooling less quickly, as the chart below shows.

Data source: Social Security Administration.

As shown above, CPI-E inflation averaged 3.4% in the first eight months of 2024. That's three-tenths of a percent higher than the average CPI-W reading.

If the CPI-E is indeed a better inflation indicator for retirees, then Social Security's COLA for 2025 will be three-tenths of a percent too low. In other words, Social Security benefits will lose purchasing power next year because the COLA underestimates inflation from the retiree perspective.

This is especially concerning because the Senior Citizens League estimates that Social Security has already lost 20% of its purchasing power since 2010 because COLAs have consistently been too low. Unfortunately, any changes to how COLAs are calculated will likely have to wait until Congress addresses the looming insolvency of the Social Security Fund, and that will likely take several years.