Should Federal Employees Retire Amidst High Inflation?

Inflation is at its highest levels in over 40 years. For federal employees who may be considering retiring, is now a good time?

With inflation running higher is now a good time to retire? Do retirement plans need to change now or in the future based on inflation?

I’ve done my best here to offer some general guidance, that said everyone’s situation is unique and I encourage you to consider that some of the specifics may not fit within your situation.

Higher inflation is impacting our lives in significant ways. If you are considering retirement, it’s certainly top of mind when it comes to making your money last.

How does inflation impact major retirement expenses? What happens to a FERS pension and Social Security income when inflation runs hot? How close are you to the income you will need? How will you invest your money to keep up? Will you be prepared and able to make changes to your expectations? 

Inflation is defined as a general increase in prices and a fall in the purchasing power of money. Inflation recently hit levels not seen in more than 40 years and the reasons are complex.

We hope this is a temporary condition and not the start of a longer-term structural problem, the reality is no one knows how long it will persist. 

Economic forces like reshoring production, newer health protocols, supply issues and a tight labor market could keep inflation rates above the Federal Reserve’s 2% target and the long-run average longer.

How does inflation impact major retirement expenses? 

It’s normal for prices to increase over time. The problem occurs when they rise quickly and faster than sources of income.

Right now, inflation is sticky and it’s likely to be here longer than we might like. With that in mind, it’s smart to plan for projected expenses in the near-term to increase faster than the Fed’s 2% inflation target and the historical levels we averaged in the recent past. 

Let’s plan for that… Let’s project inflation at 5%, 6%, or 7% levels and see how that impacts projected retirement expenses. Then we can measure how that matches up against retirement income sources. 

Let’s take a closer look at a few major retirement expenses.  

Housing expenses are subject to inflation in various ways. Home prices are at all-time highs and have risen substantially over the past 10 years. Not only does this make housing more difficult to buy, but higher home values also contribute to increased property tax assessments and more tax due. Insurance premiums will also increase based on material costs for replacement value. Household energy, furniture and appliances have been very volatile as well.

Tax rates are not directly subject to inflation; they are simply unpredictable from a policy standpoint. Federal tax brackets and many other tax parameters (deductions and credits) are indexed for inflation to help offset the reduction in purchasing power that occurs each year. Currently the Tax Cuts and Jobs Act that went into effect in 2018 sunsets after 2025.

Health care expenses have also risen substantially, a trend likely to continue, and it’s reasonable to expect future increases to outpace the general rate of inflation. Health insurance premiums also increase to account for rising costs over time. 

Food, Entertainment, Travel & Transportation. Increases in these categories is largely about demand.

The bottom line, we can expect expenses to continue to increase and at times this can be very unpredictable. 

What happens to a FERS Pension and Social Security Income when inflation is high?

The good news is that both a FERS Pension and Social Security have cost of living adjustments (COLAs) built in for those already receiving benefits.

The FERS pension COLA is based on increases in the Consumer Price Index (CPI-W). If CPI is 2% or under you receive the CPI increase, if it is greater than 2% but no more than 3%, you receive a 2% COLA increase, and if it rises above 3%, you receive CPI minus 1%. Also, to get the full COLA, a retiree or survivor annuitant must have been in receipt of payment for a full year. However, an earlier retirement may present problems – pension COLAs don’t start until age 62. Overall, this is a pretty good deal. 

Social Security Income also includes COLA increases based on the Consumer Price Index (CPI-W). Age 62 is the earliest you can claim benefits. 

While these increases may not perfectly match price increases specific to your expenses, they do provide a good hedge for these sources of retirement income against inflation. 

Both sources of income work best with a later retirement date.

What do you need from other income sources? 

I think most of us might agree the sooner the better when it comes to having the option for retirement, but that’s where things can get tricky. 

With a FERS pension and Social Security income, it’s not uncommon for folks to replace 50% to 60% of gross pre-retirement income and sometimes more depending on retirement age. 

You’ll need to make up the rest by taking money from other assets including TSP, IRAs, investment accounts, and rental properties – or plan to spend less. 

How much income can these types of assets produce? This question can get a little in the technical weeds, but from a general standpoint taking around 4% of the value each year as an income stream can be sustainable.

What does your income from all sources look like compared to projected expenses?

If things don’t go perfectly, will you be in financial trouble or putting yourself at risk of outliving your money? And, if prices continue to rise at higher rates, will your income be able to keep up? 

Congratulations if you are retiring before age 62. However, working out the details is important as creating that bridge can be challenging. 

How can you plan to keep up? 

I can’t afford to lose any money – this is one of the first things people say when talking about retiring. 

It makes perfect sense, but sometimes this mindset is damaging. 

We need to grow faster than the decline in purchasing power and that means investing to keep ahead. Investing in stocks can be an important tool to fight off inflationary forces over time.

It’s also essential that your portfolio contains a mix of conservative and growth-oriented investments. The proper mix is something specific to you and planning in advance for income needs may be a smart way to approach portfolio construction.

Some things to consider: 

  • 12 months of income set aside to allow breathing room in market disruptions. 
  • 2-4 years of living expenses in short-term positions.
  • Investing in high quality diversified stock positions.

Stay invested and do not try to time the market.

Are you prepared? 

When you sit down and work out the numbers, hopefully it shows more income than you need. However, more commonly it’s close. That’s because we tend to increase our standard of living with career and income advances over time, and this is usually not an easy thing to move backward on. 

Inflation presents challenges, especially if you are under age 62. Until FERS COLAs begin and you decide to claim Social Security, you’ll be relying on assets and other sources of income to keep up the pace, not to mention there is also a longer time frame to plan for.

If things are looking a little too close for comfort, then continuing to work longer than desired or anticipated can help. 

Of course, this is probably not the preferred answer, but let’s get creative! Look for opportunities to take a more flexible job that allows telework or reduced hours. You can continue to work toward the 1.1% multiplier, collect a pay-check, tack on contributions to investments, and your current hi-3 stays in place.

I’ve also worked with many folks who have taken full and part-time jobs outside of federal service to bridge the gap. They continue to defer Social Security and can delay tapping into their investment portfolio allowing both to grow with time.

Higher inflation won’t last forever. Certainly, it complicates the process of retiring, but with careful planning, it may still be a great time to make the transition.

The content is developed from sources believed to be providing accurate information. This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.

About the Author

Justin is the owner of District Financial Advisors, a firm focused on serving the needs of federal employees and their families. He is a Certified Financial Planner and has been helping people make the most of their money for over 21 years.