The announcement of the yearly cost-of-living adjustment (COLA) that is made by Social Security is one of the most anticipated occasions of the year, particularly for retirees and those who are dependent on benefits.
People who are on fixed incomes would not be able to have their payments stay up with inflation if the cost-of-living adjustment (COLA) were not in place. As a result, their retirement would be shadowed by the fact that they would not be able to make ends meet.
Sadly, even with the cost-of-living adjustment (COLA), it can be difficult for some people to keep up with their spending, particularly when the adjustment is lower than anticipated.
When it comes to inflation, the year 2024 has been a challenging one. It was during the first three months of the year that inflation surpassed the 3.2% cost-of-living adjustment COLA that appeared to be generous at the beginning of the year.
Expenses swiftly increased to the point where all Americans were requesting a financial break. But inflation began to decline during the second half of the year, and it continued to do so until the Social Security Administration released a cost-of-living adjustment of 2.5% for 2025.
Considering the costs that seniors built up at the beginning of the year, this may appear to be unfavorable news; however, there is a silver lining in the form of a modest cost-of-living adjustment.
The upside of a low COLA for Social Security
One of the first things that needs to be taken into consideration is the fact that Social Security was never intended to serve as a replacement for your income when you retire; rather, it was designed to supplement the pensions that are becoming less prevalent.
In order to meet their financial obligations, individuals are now expected to have private retirement savings as their primary source of income, in addition to perks that supplement these assets.
Obviously, the fact is that the situation is frequently the opposite. Social Security is the primary source of income, and savings accounts such as 401(k)s and IRAs are the sources of income that supplement Social Security.
Even while benefits are expected to be adjusted so that they do not lose their purchasing power, retirement portfolios are supposed to improve in value every year, especially during periods of low inflation. This is the reason why it is essential to have a nest egg of savings that can be drawn upon.
Due to the fact that retirees who have amassed a respectable amount of assets in investment portfolios are in a better position, it is reasonable to expect that they will be content with the same 2.5% boost that has caused other retirees to experience difficulties.
The effect of inflation on the longevity of your retirement portfolio
With the exception of situations in which your account was tax advantaged, in which case the Internal Revenue Service will be the one to calculate the mandatory minimum distribution, the decision to withdraw money from your portfolio is left up to the discretion and necessity of individual retiree.
When it comes to making investments that are more profitable and continue for a longer period of time, there are numerous ideas and tactics that claim to be the highest quality.
An example of this would be the “safe withdrawal rate,” which is a method in which you withdraw a predetermined amount of your retirement funds on an annual basis.
In the event that you adhere to the 4% rule, for instance, you would withdraw 4% of your initial balance on a yearly basis. Consequently, if you start your retirement with $500,000, you would take out $20,000 each year, with the amount increasing each year based on the rate of inflation.
The withdrawal for the following year would amount to $21,000 if inflation was 5% in the previous year. This strategy is only effective while inflation is low, as it is really simple to derail this plan when inflation is high.
It has been highlighted by Bill Bengen, the author of the 4% rule, that inflation is the most significant threat to a withdrawal plan. Bear markets and bad returns are not the most significant threats.
The economy has been unstable for some time now, with times of exceptionally high inflation that have had a detrimental influence on the finances of retirees as well as their withdrawal rates. This is because of the pandemic and the aftereffects it has caused.
They have been forced to restrict the amount of money they withdraw in order to enable their finances to survive for a longer period of time, which has most probably had a greater impact on their long-term financial goals than a lower cost of living adjustment.
Although some retirees may have a sense of disappointment due to the reduced cost-of-living adjustment (COLA), the positive aspect is that lower inflation typically equals better stability for their overall financial picture.
It is possible that, in the long term, the modification will make things simpler for them financially, despite the fact that it is very minor.