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Should Retirees Take Raises for Inflation?

Inflation on the Rise

You may have noticed that inflation is on the rise.  In fact, as of October 2021, inflation is reaching 30-year highs.  Retirees who have been living on a relatively fixed budget suddenly find themselves wondering if it's time to increase their portfolio withdrawals to offset inflation.  Even the Social Security Administration has noticed inflationary factors; to compensate, the SSA will increase Social Security payments by 5.9% in 2022.

Automatic Raises for Inflation?

We commonly get asked by retirees if they should take automatic raises for inflation.  In other words, if the government says inflation in the past year was 3 percent and last year’s withdrawal was $60,000, then your new withdrawal for the coming year would
be $61,800 ($60,000 * 1.03). Inflation is up, so I should get a raise, right?

In years of working with retirees, we have found automatic raises for inflation to be unnecessary. Most retirees aren’t facing an increase in housing costs because they either have paid off the mortgage or have a fixed rate mortgage. Medical-related inflation could be significant for some people later in their retirement, but many health-care expenses seem to be adequately covered by Medicare for those over age 65.

Instead, the main inflationary expenses actually felt by retirees tend to be things such as food, gas, and travel.  While inflation can be alarming, these items tend to not be a major component of retiree spending.  So, if retiree inflation isn’t running all that high, why take money out of the retirement portfolio before you have to? We find it is better to leave the
money in the portfolio to continue working and potentially growing for you.

We suggest retirees calculate their withdrawal rate on the day they retire and then take out that same number of dollars each year.  

The Hidden Emergency Fund

When you do that, an interesting thing happens. You discover you can get along just fine on that fixed amount. We see it all the time  with our clients. Meanwhile, the money not withdrawn creates a de facto emergency fund that you can call upon when one of life’s little problems pops up. The furnace goes out, the roof needs a repair, the car won’t start, or one of your kids needs your help. We handle these as a onetime distribution and keep the base withdrawal the same.  Once the onetime need has passed and the client returns to their normal withdrawal pattern, the hidden emergency fund starts to build again.

This hidden emergency fund, if not withdrawn, could really add up over time. As a hypothetical example, let’s assume you retire with $1 million and plan to withdraw 5 percent ($50,000) of the portfolio each year.  Let's assume the portfolio grows at 6 percent per year net of fees and expenses, and inflation is 3 percent. You elect to take annual  automatic raises for inflation.  After ten years, the portfolio has an ending value of $1,001,269 or about where it started.

But what if you hadn’t taken those automatic raises? The portfolio would be worth $1,092,266. That’s an extra $90,000 available to you for emergencies. If you are like many
of our clients, you will like knowing this extra is there for you.

Which Approach Is Right For You?

Retirement withdrawals are complicated.  You have to be sure you don't run out of money, account for taxes and deal with inflation.

We've been helping clients prepare for, and thrive in retirement for over three decades. Our clients' continued financial success is exceeded only by their success at the game of life.

When we build retiree portfolios at Oxford, we seek a balance between Stability and Growth following the principles outlined in our proprietary Power of 5 Investing system. Our goal is to help clients achieve inflation-beating growth in their wealth, while managing through market downturns, ultimately helping clients leave a legacy to the people and places they love. Our system has been battle tested in 25+ years of market ups and downs and is ready for whatever the market can throw at it.

If you'd like to discuss how to handle inflation in retirement, click on the link below.  We're happy to offer a free Get Acquainted meeting.

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