One of the most-anticipated events of the year for retirees and people who depend on Social Security benefits is the annual cost-of-living adjustment (COLA) announcement. People on a fixed income would not be able to keep up with inflation if not for the COLA.
This would make their retirement less enjoyable because they would not be able to afford to live on their income. It’s sad that for some people, it’s still hard to keep up with costs even with the COLA, especially when the increase is less than expected.
Inflation-wise, 2024 has been a rough year. During the first three months of the year, inflation rose faster than the 3.2% COLA, which at first seemed like a fair amount. Costs quickly rose until everyone in the U.S. was begging for a financial break.
But prices went down in the second half of the year until the Social Security Administration announced a 2.5% COLA for 2025. Given the costs seniors racked up at the start of the year, this may seem like bad news, but there is a silver lining in a low COLA.
The upside of a low COLA for Social Security
First, it’s important to remember that Social Security was never meant to replace your income when you retire. It was only meant to provide pensions, which are becoming less common. People should have private retirement savings as their main source of income and benefits to add to them in order to pay their bills.
In reality, though, it’s usually the other way around: savings accounts like 401(k)s and IRAs are used to supplement Social Security. Because of this, it is helpful to have a nest egg of savings. This is because retirement portfolios are meant to grow in value every year, especially when inflation is low.
This is because benefits are supposed to be changed so that they don’t lose their purchasing power. This is good news for retirees who have saved a good amount of money in investments. This means that they should be happy with the same 2.5% raise that is making other people unhappy.
The effect of inflation on the longevity of your retirement portfolio
It’s up to each retiree to decide how much money to take out of their portfolio, unless their account was tax-advantaged in which case the IRS will decide the required minimum distribution. There are a lot of ideas and plans that say they are the best way to make investments last longer and make more money.
The “safe withdrawal rate” is an example of this. This is when you take out a certain amount of your retirement savings every year. For instance, if you follow the 4% rule, you would take out 4% of your initial balance every year.
For example, if you retire with $500,000, you would take out $20,000 a year, with the amount going up each year to account for inflation. If inflation was 5% one year, $21,000 would be taken out the next year.
This plan can easily fail if inflation gets too high, so it only works when inflation is low. Bill Bengen, who came up with the 4% rule, has said that inflation, not bear markets or low returns, is the biggest threat to a withdrawal strategy.
Because of the pandemic and its effects, the economy has been unstable for a while now, with times of very high inflation that have hurt retirees’ finances and the amount they take out of their retirement accounts.
Because they wanted their money to last longer, they had to cut back on withdrawals. This has had a bigger effect on their long-term financial goals than a smaller COLA.
People who are retired might be upset about the lower COLA, but on the plus side, lower inflation usually means their overall finances are more stable. These small changes could help their money in the long run, even though they are only temporary.
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