The annual cost-of-living adjustment (COLA) announcement from Social Security is one of the most anticipated occasions of the year, particularly for retirees and those who rely on benefits.
Without the COLA, many on fixed incomes would be unable to keep up with inflation, clouding their retirement prospects. Unfortunately, for others, even with the COLA, it is difficult to keep up with spending, particularly if the increase is less than planned.
In terms of inflation, 2024 has been a challenging year. In the first quarter of the year, inflation outpaced the 3,2% COLA that appeared generous at first, and expenses swiftly rose until Americans were all begging for a financial break. However, inflation cooled in the second half of the year, until the Social Security Administration issued a 2.5% COLA for 2025.
This appears to be bad news given the expenses seniors incurred at the start of the year, but a low COLA provides a silver lining.
The upside of a low COLA for Social Security
The first thing to remember is that Social Security was never intended to replace your income in retirement, only pensions, which are becoming increasingly rare. To offset expenses, people are now expected to have private retirement savings as their primary source of income, with additional advantages.
Of course, in many cases, Social Security is the primary source of income, with assets such as 401(k)s or IRAs serving as supplements. This is why it is critical to have a nest egg of savings to draw on, because, while benefits are supposed to be adjusted so that they do not lose purchasing power, retirement portfolios are supposed to grow in value year after year, especially during periods of low inflation.
This fact benefits retirees who have collected a sizable amount of money in investment portfolios, which means they should be content with the same 2.5% increase that has worried others.
The effect of inflation on the longevity of your retirement portfolio
Unless your account was tax-advantaged, in which case the Internal Revenue Service will decide the required minimum distribution, withdrawing funds from your portfolio is up to each retiree’s judgment and needs. There are numerous theories and tactics that claim to be the best for making investments last longer and provide higher returns.
One such example is the “safe withdrawal rate,” in which you remove a set percentage of your retirement assets each year. For example, if you follow the 4% rule, you will take 4% of your initial amount each year. So, if you start retirement with $500,000, you’d withdraw $20,000 every year, increasing each year based on inflation.
If inflation is 5% one year, the following year’s withdrawal will be $21,000. This only works while inflation is modest; rising inflation can rapidly derail this scheme. Bill Bengen, the inventor of the 4% rule, has stated that inflation, rather than bear markets or low returns, poses the greatest threat to a withdrawal strategy.
Given the epidemic and its aftermath, the economy has been turbulent for quite some time, with periods of extraordinarily high inflation that have had a severe influence on retirees’ finances and withdrawal rates. They have had to decrease their withdrawals in order to keep their monies in place longer, which has undoubtedly had a greater impact on their long-term financial goals than a lower COLA.
While some retirees may be disappointed by the lesser COLA, the positive is that lower inflation often indicates more stability for their overall financial situation. So, even though the change is minor, it may make things easier for their finances in the long run.
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