Are the clouds of inflation lingering over your head? We are here to help clear the way to a new day that encourages new perspectives based on facts and experience. When it comes to Social Security benefits, inflation plays a critical role in determining your benefit amount, and your financial advisor should have a complete view of your finances to help keep you on track for retirement.
As retirement planners and investment advisors in Greenville, SC, we have some insight on how to keep striving toward your financial goals amidst the pressures of inflation.
Why should I worry about inflation when planning for retirement?
Inflation can disrupt your retirement strategy by devaluing your money, exposing you to the risk of insufficient assets for the latter portion of your life. You experience the impact of inflation on the vital necessities of a happy retirement, including healthcare, leisure, and travel, which cost more when inflation is present.
For example, many retirees like to downsize by selling their homes and becoming renters again. Retirees must keep in mind the impact of inflation on rent because this expense could grow faster than anticipated.
If you envision extensive travel during retirement, note that airline prices increased almost 38% from May 2021 to May 2022, spurred by an inflationary 49% rise in gasoline prices.
Social Security benefits are indeed scaled to inflation, but the same cannot be said of other important retirement assets such as pensions, IRAs, and 401ks — it is up to you (and your fee-only investment advisor) to manage these assets for inflation.
The Employee Benefits Research Institute conducted a survey and found that almost 46% of retirees spend more in the first two post-retirement years than in the last two pre-retirement ones. Moreover, the survey reported that 28% of retired households were spending at least 20% more during the same period, in part due to lifestyle inflation.
Why inflation matters to social security recipients
You may be on a fixed income when you claim your Social Security benefits. Alternatively, you may have new sources of income from self-employment, part-time jobs, or side hustles. In any case, inflation robs your income of its purchasing power unless it is adjusted for increases in the cost of living.
The problems with Social Security’s cost of living adjustment (COLA) include:
- Inflation’s impact depends on a retiree’s lifestyle: there is no guarantee that your personal cost of inflation will be the same as the Social Security COLA. If your spending is overweighted toward the highest components of inflation, your money could lose value faster than Social Security’s attempts to keep up. The Senior Citizens League estimates that Social Security benefits have lost about a third of their purchasing power since 2000, indicating that COLAs are inadequate.
- Medicare costs can rise quickly during inflationary times. 2022 saw a significant increase in Medicare Part B premiums, from $148.50 in 2021 to $170.10 in 2022. As retirees age, higher Medicare costs become increasingly concerning.
- Social Security benefits are only a part of your retirement income streams. As a wealthy retiree, it’s likely that the income from your retirement assets will greatly exceed that from Social Security, at least in the early years.
In other words, Social Security’s COLA attempts to protect only Social Security benefits. What about the rest of your income?
A large COLA, such as that expected for 2023, will have knock-on effects:
- If you haven’t attained full retirement age (FRA), which is approximately 67, and continue to work while receiving Social Security benefits, you face higher withholding of these benefits until you reach the FRA. The withholding limit increases with inflation, meaning that you may be able to earn more income without a benefits reduction.
- In times of inflation, the maximum taxable Social Security earnings limit may increase. The cap on earnings subject to Social Security taxes had been $147,000 in 2022. Expect this limit to rise in 2023 because it also is tied to inflation. High earners will have to pay more of their income to Social Security.
- The maximum Social Security benefit available to an individual rises with inflation. In 2022, the limit had been $4,194/month, but this should increase in 2023. This affects high earners who worked at least 35 years and postponed their claim until 70.
How inflation affects your social security benefits
Nominally, the Social Security COLA is supposed to protect your benefits from inflation by adjusting the amount you receive each year. In 2022, the COLA increase of 5.9% was the highest in almost 40 years. The COLA is based upon government indexes of consumer price and takes place on December 1 each year, payable starting in January of the new year.
The COLA is equal to the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) “from the average for the third quarter of the current year to the average for the third quarter of the last year in which a COLA became effective.” The Bureau of Labor Statistics is responsible for calculating the CPI-W each month.
What happens when there is no inflation?
A COLA is not applied during periods without inflation. There were no COLAs in 2009, 2010, and 2015. Social Security uses the last year it paid a COLA as the base level for calculating a new one.
While an economy with no inflation may seem ideal, it may presage a deflationary or recessionary period. Deflation causes wages to fall and is considered harmful to economic growth. It also removes dollars from the economy, reducing aggregated demand, curbing production, and heightening the chance of recession.
How do I combat inflation? A financial advisor can help!
Retirement financial planners will tell you that worry is not the correct response to inflation—action is. Important actions include:
- Delaying your Social Security claim until age 70, letting COLAs compound until then
- Increasing your savings rate before retirement and making maximum use of your retirement accounts
- Rebalancing your portfolio in favor of stocks and other assets that benefit from inflation
- Ensuring you maintain broad diversification across multiple asset classes
- Locking in rising bond yields by laddering new purchases, including tax-free bonds
- Reducing your spending and liquidating assets with significant expenses, such as a second home or a yacht you seldom use
- Considering your plans to relocate and/or downsize
- Thinking about other sources of revenue once you retire
You can use your career or hobby expertise to start a small business you can run from home. You may want to consult, lecture, or write on your topics of expertise.
If you plan on retiring in Greenville SC, we invite you to speak with one of our retirement financial planners (aka, your independent advocate).
We can show the best ways to grow and deploy your assets before retirement and how to draw them down in a tax-efficient manner after you retire. In addition, our CERTIFIED FINANCIAL PLANNER™ in Greenville SC will help you create an estate plan that provides significant benefits now and in the future.