Social Security’s annual cost-of-living adjustment (COLA) announcement is one of the most awaited moments of the year, especially for retirees and those who depend on benefits. Without the COLA, those on fixed income would not be able to have their payments keep up with inflation and thus their retirement would be clouded by their inability to make ends meet. Sadly, for some, even with the COLA it is hard to keep up with expenses, especially when the adjustment is lower than expected.
2024 has been a complicated year inflation wise. The first trimester of the year saw inflation outpace the 3,2% COLA that seemed generous in the beginning, and expenses quickly climbed until Americans were all asking for a financial reprieve. But the second half of the year had inflation cooling down until the Social Security Administration announced a 2.5% COLA for 2025.
This seems like bad news considering the expenses seniors racked up in the beginning of the year, but there is silver lining in a low COLA.
The upside of a low COLA for Social Security
The first thing that must be taken into account is that Social Security was never meant to replace your income in retirement, just the pensions that are now increasingly uncommon. To cover expenses, people are now expected to have private retirement savings as their main source of income and benefits to complement them.
Of course, he reality is often the other way around, Social Security is the main source of income and savings like 401(k) or IRAs are the complementary sources of income. This is why it is important to have a nest egg of savings to be able to draw upon, because even if benefits are supposed to be adjusted to not lose their purchasing power, retirement portfolios are meant to increase in value every year, especially in times of low inflation.
This fact favors retirees who have accumulated a decent amount of savings in investment portfolios, which means that they should be happy with the same 2,5% raise that has other troubled.
The effect of inflation on the longevity of your retirement portfolio
Unless your account was tax advantaged, in which case it is the Internal Revenue Service who will determine the required minimum distribution, taking money out of your portfolio is up to each retiree’s discretion and need. There are many theories and strategies that claim to be the best one in order to make the investments last longer and yield more.
One such examples in the “safe withdrawal rate,” where you take out a certain percentage of your retirement savings each year. For example, if you go with the 4% rule, you’d take 4% of your starting balance annually. So, if you begin retirement with $500,000, you’d withdraw $20,000 a year, adjusting upward each year based on inflation. If inflation were 5% one year, the next year’s withdrawal would be $21,000. This only works with low inflation, as high inflation can derail this plan quite easily. Bill Bengen, the creator of the 4% rule, has emphasized that inflation is the biggest threat to a withdrawal strategy, not bear markets or poor returns.
Considering the pandemic and its aftereffects, the economy has been volatile for a while now, with periods of extremely high inflation that have negatively impacted the finances of retirees as well as their withdrawal rates. They have had to reduce their withdrawals to keep their funds lasting longer, which has most certainly had a bigger impact than a smaller COLA on their long term financial goals.
While some retirees might feel let down by the smaller COLA, the upside is that lower inflation generally means better stability for their broader financial picture. So, even though the adjustment is small, it could make things easier for their finances in the long run.
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