For years, the rate of inflation in the United States was low, which benefited American consumers by keeping their dollar’s purchasing power stable and robust. That is no longer the case.
Higher inflation is bad for everyone, but it is especially bad for those on fixed incomes, such as pensioners and retirees. If their pension incorporates a cost-of-living adjustment, or COLA, some retirees get a “rise” in their monthly checks during inflationary periods. Social Security claimants are among those who benefit from such hikes, with the Social Security Administration announcing in October that benefits would be increased by 5.9% in January to reflect the recent increase in consumer prices.
However, according to Alex Brown, research manager at the National Association of State Retirement Administrators, a nonprofit organization, millions of public pension recipients, including one-quarter of state and local government employees, do not participate in Social Security. Brown stated, “This figure includes nearly 40% of public-school teachers and over two-thirds of firefighters, police officers, and other first responders.”
In recent years, public pensions in at least 31 states have cut or eliminated cost-of-living increases as their payout obligations grew larger than the funds available to support them. Firefighters, teachers, police officers, and other employees in four other states Iowa, New Jersey, Washington, and Wyoming are now behind the eight ball.
Does inflation affect pensions?
After retirement, benefits are usually not indexed for inflation. As a result, an increase in the rate of inflation would reduce the worker’s real benefits in the years after retirement, making them less than projected.
How does inflation effect pensions?
Although many employers have moved away from pensions, those who are fortunate enough to still have one may not want to rely on it as much in retirement. In retirement, having many sources of income is the greatest plan.
Pensions aren’t all created equal. Many private pensions do not adjust for inflation, which implies that retiree payouts do not change as inflation rises. Some public pensions, such as those offered by municipal and state governments, include a cost-of-living adjustment, but it may be insufficient to keep pace with inflation, limiting pensioners’ buying power.
And, according to Bridget Early, executive director of the National Public Pension Coalition, not all public pensions account for inflation. Kansas hasn’t given a COLA in more than two decades, which means some workers are receiving checks in 1990s dollars.
States can issue a “13th check” that adjusts for inflation, but only a few have done so in recent years, according to Early, and the regulations for authorizing one differ from state to state. Many retired public employees, especially those who are not eligible for Social Security, may face a terrible position due to a lack of inflation protection, according to Early.
Retirees without a cost-of-living adjustment should diversify and amplify their retirement income sources, regardless of the sort of pension they have. This could take the shape of a retirement account, such as a 401(k) or an IRA, or part-time work during their golden years. Social Security benefits are adjusted for inflation, but not nearly as much as pensioners require (in part because it is tied to the Consumer Price Index for urban workers, not older Americans).
Are pensions inflation-indexed?
Ad hoc raises aren’t tied to a price index; instead, retirees’ current pensions are normally increased by a percentage of their current benefit, which is usually a fixed sum. For example, pension plan managers may elect to give all annuity recipients a 3% raise.
Do company pensions take inflation into account?
Pensions are a fantastic way to put money aside for the future. Your money is not only invested with the goal of increasing in value over time, but your employer and the government will also contribute to it.
However, both while saving for retirement and when drawing down in retirement, pensions are not immune to the impacts of inflation.
Before retirement
The money you put into your pension is invested, most commonly in the stock market, in order to grow over time. Pension funds expanded by an average of 7.4% every year between 2015 and 2019, substantially faster than the average inflation rate of 1.53% during the same time.
Even yet, inflation erodes the value of your pension every year; if it increased in value by 4% but inflation was 2%, your pension would have grown by just 2% in’real-terms’.
If your pension rose at a rate of 2% per year, it would be worth 122,000 in cash terms, but you’d be no better off in real terms because the cost of everything would have risen by 2% (workplace inflation). Your 122,000 could buy the same things that your 100,000 could ten years ago.
If your pension grew at 4% annually, it would be worth 148,000 financially, and you would be much better off in real terms. Your 148,000 may get you a lot more than your 100,000 could have gotten you ten years ago.
If your pension increased at less than 2% each year, you’d be worse off in real terms because inflation would have exceeded your pension’s growth.
In the instances above, we haven’t included recurring contributions, but the effect on the money you send in would be the same.
After retirement
You’ll want your pension to last as long as possible once you retire. What you do with your retirement funds will determine how inflation affects it.
If you keep your pension invested and take regular withdrawals, inflation will eat away at your savings. However, if the growth of your investments outpaces inflation, this could be countered.
If you buy an annuity with your pension, inflation may or may not affect your annuity income. A ‘fixed annuity’ will be eroded by inflation over time, whereas a ‘escalating annuity’ will increase over time to keep up with inflation.
Are pensions cost-of-living adjusted?
Approximately three-quarters of state and local government pension plans include some sort of automatic cost-of-living-adjustment (COLA), i.e., one that does not require the plan sponsor’s approval or action (the legislature or city council).
How can I safeguard my pension against inflation?
You can request that your pension increase in line with the Retail Price Index (RPI) each year, or at a predetermined rate, to safeguard your income from inflation (3 percent or 5 percent each year are the most common).
Does Social Security take inflation into account?
Yes, Social Security benefits are adjusted higher to account for inflationary effects. The cost-of-living adjustment is the official name for this Social Security cost-of-living rise (COLA). Every year, the Social Security Administration (SSA) decides whether or not to include a COLA in the following year’s payment and, if so, how much it should be. The program’s contribution levels are likewise related to inflation.
Is Social Security adjusted for inflation?
Because of rising inflation, Social Security recipients are receiving the biggest cost-of-living increase in decades. The rise of 5.9% went into effect in January.
Are pension annuities adjusted for inflation?
An inflation-linked annuity will increase in value in lockstep with the retail price index each year. This will safeguard your annuity against inflation, but at a considerably lesser rate. You’ll need to think about your specific circumstances, such as your health, whether you want an annuity income for a short or long period of time, and whether you want to leave an income to a spouse or partner when you die.
How can I keep my money safe from UK inflation?
Inflation may have dropped in recent months, but savers still have a fight on their hands if they wish to avoid its corrosive effects.
We’ll look at how taking certain risks with your money can help you keep your money’s value above inflation.
Shift longer term savings into equities
You might have some money in a savings account. After all, it’s recommended that you save away roughly six months’ worth of earnings as an emergency fund. However, you may discover that you have more than you require. If that’s the case, think about putting some of it into investments that have a better chance of long-term growth.
Equities have historically been the most successful assets for fighting inflation over the long term but you must be comfortable with your investments rising and falling in value.
Choose your investments wisely
Other investments, if you know where to search, can produce returns that are higher than inflation. Bond funds, for example, could be included in a portfolio of investments because they invest in debt issued by governments and/or enterprises seeking to raise financing. Throughout their lives, bonds pay a defined rate of interest, known as the coupon, and should refund the original capital at maturity. To spread risk, bond funds invest in a variety of debt instruments.
A financial adviser can help you create a portfolio that takes advantage of all available investment opportunities.
Maximise tax efficiency
After you’ve figured out how to fight inflation, think about how tax-efficient your assets are. ISAs and pensions are both tax-advantaged vehicles for saving and investing for the long term.
ISAs allow you to save up to 20,000 a year in tax-free growth and income on investments, as well as tax-free withdrawals. Meanwhile, depending on your taxable income, pension payments may be eligible for income tax relief of up to 45 percent.
When you can afford it and while they’re still accessible, it’s a good idea to take advantage of hefty tax breaks over time. This way, you may take advantage of compound growth or earning returns on your returns to help you keep up with inflation.
Seek expert advice
A sound investment strategy should include a diverse portfolio of assets and the use of tax-advantaged investment vehicles.
We can put together a diversified portfolio that is geared to your long-term financial goals, risk tolerance, and inflation protection. Get in touch with us right away to learn more.