By Jon Powell, CFP®
Inflation is all over the news these days along with constant talk of how your purchasing power is being washed down the drain. If you’re like many of our clients, you’re probably wondering what this means for your government pension and if there’s any way to protect your savings. At Ferguson Johnson Wealth Management, we’re here to answer your questions about inflation and guide you through this troubling time. Here’s everything you need to know about how inflation might affect your government pension.
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 January 2022 shows that inflation has risen an astounding 7.5% 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.
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be higher when you do retire (thanks to inflation) and your already weakened savings will be further reduced when it’s withdrawn.
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.
There are several ways to protect 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 Ferguson Johnson Wealth Management 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 retirees to make wise decisions for the future, reach out to us at 301-670-0994 or by email at email@example.com.
Jon Powell is a financial planner and portfolio manager at Ferguson Johnson Wealth Management, an independent, fee-only fiduciary firm that has been helping clients plan for and enjoy retirement for more than 40 years. With more than 10 years of experience, Jon is passionate about providing unbiased advice that puts his clients first. He considers it a privilege to carry some of the financial burden for his clients and educate them so they can make empowered decisions for their futures. Jon is also the primary author and curator of the Ferguson-Johnson Wealth Management blog.
Jon graduated from Virginia Polytechnic Institute and State University with a bachelor’s degree in financial planning and holds the CERTIFIED FINANCIAL PLANNER™ certification. When he’s not serving his clients, you can find Jon spending time with his wife, Erica, and their pets, a black lab named Nugget and an orange tabby cat named Kiwi. He loves to play tennis and golf and won’t turn down a good board game. Jon is a diehard fan of D.C.-area sports teams; you might see him at a Washington Nationals game. To learn more about Jon, connect with him on LinkedIn.