By Jay Shareef and Chris Rhoads
You don’t have to pay attention to the news to see how inflation is affecting everyone, including the average consumer. If you have filled up your car with a tank of gas, bought a week’s worth of groceries, or purchased anything online or in a retail shop, you have likely felt the effects of rising costs on nearly all consumer goods and services.
While inflation is all over the news these days, along with talk of how your purchasing power is dwindling, you may have started wondering what this means for your government pension and if there’s any way to safeguard your savings. At WealthFlow Financial, we’re here to answer your questions about inflation and guide you through this challenging time. In this article, we’ll define inflation, discuss how it affects your pension before and after retirement, and how to safeguard your savings.
What Is Inflation?
Inflation is the general increase of prices and goods, which can lead to an erosion of your purchasing power over time. It essentially means that every dollar you earn today is worth less than it was yesterday.
The Consumer Price Index (CPI) is a common measure of inflation. The most recent CPI report from April 2022 shows that inflation has risen an astounding 8.3% over the past year![1] That is significantly higher than the typical 2% rise we see in an average year, and it’s the highest 12-month increase since February 1982.[2]
So, how does inflation affect your government pension? Well, the answer really depends on whether you are still accruing benefits, or if you have already retired.
Inflation and Your Pension Before Retirement
Before you retire, the money paid into your pension is invested in various assets throughout the stock market, which helps your benefit grow faster than inflation. Though the exact rate of return you will achieve is specific to your pension plan, the stock market as a whole has averaged a 10% historical return.[3] Using this amount as an example, we can see how inflation affects your pension over time.
At a 10% annual return, your pension would have only grown 2.5% (10%-7.5%) in real terms from January 2021 to January 2022. Now imagine that your pension only grew 8% over the course of the year, while inflation remained the same. Your real rate of return would only be .5%! Over time this can drastically affect how much money you have saved when it comes time to retire. Not only that, but prices will also be higher when you do retire (thanks to inflation) and your already weakened savings will be further reduced when it’s withdrawn.
Inflation and Your Pension After Retirement
In retirement, you will receive annuity payments based on the total benefit amount accrued during your working years (contributions and earnings). At this point, you have locked in the value of your plan, and you are guaranteed a set income for life.
Government employees retiring under the Federal Employee Retirement System (FERS) will also receive cost-of-living adjustments (COLA) that are meant to offset the rate of inflation. However, it doesn’t solve the inflation problem entirely due to provisions in the law. If inflation is 2% or less, your annuity payment will be adjusted by the full COLA. But if inflation is greater than 2%, your annuity payment will get the COLA minus 1%. This can have a significant impact on your purchasing power over time, especially because your ability to earn additional income is reduced in retirement.
Another issue to consider is deciding when to retire and start your pension benefits. This can be a tricky decision, especially in a high inflation environment. You may feel pressured to take your benefits sooner rather than later out of fear that inflation and poor market performance could devalue your savings. On the other hand, you may want to wait in order to recapture earnings when inflation subsides and the market levels out. Regardless of which option you’re considering, choosing when to retire is a decision that should be thoroughly assessed in the context of your overall financial plan.
Safeguard Your Savings From Inflation
There are several ways to safeguard your savings from the risk of inflation. Working longer, contributing to other forms of savings, and diversifying your income are just a few options. We at WealthFlow Financial can help you navigate the current high-inflation environment so that you can retire with confidence. If you would like to learn more about how we empower federal employees to make wise decisions for the future and you don’t already have an advisor helping you, reach out to us at (301) 798-5250 or schedule a phone call now.
About Jay
Jay Shareef is vice president, financial advisor, federal benefits consultant, and co-founder at WealthFlow Financial. As a U.S. Army veteran, Jay is passionate about helping federal employees create a bulletproof plan for retirement and navigate the often confusing and complicated federal benefits landscape. He spends his days educating and providing clients with unbiased insurance benefits and retirement strategies to help his clients create guaranteed income for life. As a problem-solver and trustworthy resource, Jay always puts his clients and their needs first so they can find financial peace of mind. To learn more about Jay, connect with him on LinkedIn.
About Chris
Chris Rhoads is a co-founder and vice president of WealthFlow Financial. As a registered investment advisor and independent financial professional, Chris is committed to helping his clients in retirement and he takes a holistic approach to financial planning that includes insurance and risk management, investments and wealth management, retirement income planning, and estate and tax planning. Chris has been married to his wife, Tia, since 2009 and they live in Frederick, MD, together with their two young daughters. In his free time, Chris enjoys traveling, watching sports, and being active in causes about which he cares passionately. To learn more about Chris, connect with him on LinkedIn.
[1] https://www.bls.gov/news.release/pdf/cpi.pdf
[2] https://www.bls.gov/news.release/pdf/cpi.pdf
[3] https://www.nerdwallet.com/article/investing/average-stock-market-return