Last week 69.1 million Americans receiving Social Security benefits learned they’ll be receiving a 5.9% cost of living adjustment (COLA) beginning in January 2022, which is the largest inflation adjustment in 40 years. The annual increase is tied to the Consumer Price Index and September’s CPI increased to 5.4% annualized. While this COLA increase may seem like it covers inflation, the Producer Price Index rose to 8.6% annualized, indicating our inflation may not be as transitory as initially thought.
While Social Security benefits have increased about 55% over the past 21 years, the COLA increases haven’t kept pace with seniors’ housing costs, which have increased nearly 118%, and health care costs, which have increased 145%, over the same period.
For retirees living on a fixed income, inflation is a critical variable in their financial plans. Underestimate inflation, and retirement savings may not last as long as planned, but overestimate inflation, and investors could be withdrawing more than they need.
At Henssler Financial, we assume inflation at 4.6% per year in our financial plans. Initially, that might seem very high, but given we are seeing 5.4% inflation today, suddenly, it doesn’t seem unreasonable. We also review and update clients’ financial plans every two years, which allows us to recalculate how inflation and their spending have affected their plans.
Client spending? Absolutely. Client spending is the No. 1 factor that affects a financial plan. As part of an overall financial plan, we run cash flow projections assuming the assets are depleted when the youngest spouse reaches age 92. This is where we use the 4.6% inflation factor. We get the spending estimates directly from the client—another reason we revisit and revise plans every two years. The longer we work with a client, the more accurate the spending estimates will become.
When analyzing how client spending affects the financial plan, we also calculate what the maximum amount of spending could be, assuming the assets last until age 92 for the youngest spouse. We want to see clients using less than 85% of their maximum spending. If a client’s maximum outlay is only $5,000 more than actual expenditure per year, there is little room for change—like rampant inflation—or emergencies.
There have been times when the cash flow projections indicate that clients need to curb their spending and begin saving more. However harsh that may be, it is better to know that now when they can make changes than at 80 when they no longer have the option to push out their retirement date.
The calculations of actual spending, 85% of maximum spending, and maximum spending provide a much more accurate withdrawal rate for the client compared to a blanket rule of “spend 4% of assets per year.” Furthermore, the spending numbers combined with the cash flow projection that accounts for portfolio growth, inflation, and specific spending needs, also help determine your portfolio’s asset allocation between fixed-income investments and growth investments.
If you have questions on how to account for unknowns like inflation in your financial plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
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