One of the most-anticipated events of the year for retirees and people who depend on benefits is when Social Security announces the annual cost-of-living adjustment (COLA).
Many people on fixed incomes would not be able to keep up with inflation without the COLA, which would make their retirement plans less likely.
For some people, it is still hard to keep up with spending, even with the COLA, especially if the increase is less than expected.
This has been a tough year for inflation in 2024. Inflation was higher than the 3.2% COLA in the first quarter of the year.
This seemed like a lot of money at first, but costs quickly went up until everyone in the U.S. begged for a break. It did go down in the second half of the year, though, until the Social Security Administration announced a 2.5% COLA for 2025.
Given the costs seniors had at the beginning of the year, this seems like bad news. However, a low COLA is good news.
The Advantages of a Low COLA for Social Security
First, keep in mind that Social Security was never meant to replace your income when you retire. It was only meant to replace pensions, which are becoming less common.
People are now expected to use their private retirement savings as their main source of income to cover their costs, which has other benefits as well.
Of course, for many people, Social Security is their main source of income, with assets like 401(k)s or IRAs helping them out. In this case, having a nest egg of savings is very important.
This is because, while benefits are supposed to be changed so that they do not lose value, retirement portfolios should grow in value every year, especially when inflation is low.
This is good news for retirees who have a lot of money in investments. This means that they should be fine with the same 2.5% increase that has other people worried.
How inflation affects the lifetime of your retirement portfolio
If your account was tax-advantaged, the IRS will decide the required minimum distribution. Other than that, it is up to each retiree to decide how much money to take out of their portfolio based on their own needs and preferences.
A lot of different ideas and strategies claim to be the best way to make investments last longer and give you better returns.
The “safe withdrawal rate” is one example. With this plan, you take out a set amount of your retirement savings every year. Say you follow the 4% rule, you will take 4% of your initial amount every year.
If you retire with $500,000, you would take out $20,000 a year, plus the amount that goes up each year due to inflation. If inflation is 5% for a year, the amount taken out the next year will be $21,000.
This only works when inflation is low; if inflation goes up, this plan can quickly fall apart. 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 epidemic and what happened after it, the economy has been unstable for a long time, with periods of very high inflation that have had a big effect on retirees’ savings and withdrawal rates.
They have had to cut back on withdrawals to keep their money in the account longer, which has definitely hurt their long-term financial goals more than a lower COLA.
Some retirees may be upset that the COLA is lower, but on the bright side, lower inflation usually means their overall finances are more stable. So, the small change might help their money in the long run, even though it is not essential.
