The Two Enemies of Retirement

These two things will put a dent in federal retirees’ finances if not addressed.

Ask 100 people in their 50s and 60s: “What are some of the biggest issues in retirement?” You’ll likely hear answers like “insomnia,” “too many vacation destinations (and not enough time),” and “pickleball injuries.”

Here, we’re focusing on two other problems. In our opinion, these are the two most overlooked enemies of retirementinflation and taxes.

How can we deal with them? 

Inflation: A Quick History Lesson

Recently, inflation has spiked. It’s all over the news. But even if that weren’t the case, inflation is a reality that retirees (or soon-to-be retirees) need to plan for. 

Did you know that $1 in 1913 would be worth $29.93 today? That’s almost 3,000% inflation over the last century!

If we fast forward and look just at the years 2015 to 2022, we find 25% inflation. In other words, what cost $1 just seven years ago now has a price tag of $1.25. 

However, since the average retirement is around 30 years in length, let’s look at inflation over the 30-year period from 1992 to 2022. What we find is that something that costs $2.11 today cost only a dollar back in 1992. That’s a 111% increase. 

Inflation: A Fact We Can’t Ignore

The point is, as you plan for retirement, you have to factor in the reality of inflation. Perhaps we should lump it together with “death and taxes” as one of life’s certainties. Things simply cost more as the years go by. 

At Christy Capital, we call inflation an “enemy of retirement” because it erodes your buying power. That’s a big deal in the years when you are no longer working and bringing home a paycheck. 

In short, inflation can cause you to spend down your assets too quickly. It can prevent you from enjoying the comfortable retirement you hoped for. 

Inflation: How to Offset It

If inflation is a reality for retirees, what can we do to offset it?

One obvious way is to live below your means. Look for ways to control (and even lower) your expenses. By simplifying your life, you spend less, leaving more to set aside. 

Ideally, you want to invest in such a way that your assets and income will be able to outpace inflation long-term. So, if inflation is averaging 5%—just to pick a random number—can your investments earn 6 or 7%? There are no guarantees, but if you can beat inflation while still drawing from your assets, that’s ideal.

That’s the two-fold trick in preparing for inflation: 1. Invest your money in a way that suits your risk tolerance level; but 2. Try to make enough to offset inflation over a retirement that could last 30 years (or more).

Many clients are able to do this—and sleep better at night—by allocating a portion of their portfolio to market investments that tend to beat inflation over time… while they put the rest in “less risky” assets like bonds or cash.

This is where a wise plan—and a trusted financial planner—are indispensable. An expert advisor can help you strike that healthy balance between being overly conservative in your investing (due to worries about stock market risk) and also needing to get a return that outpaces inflation and produces enough assets for you to live in retirement.

Inflation: Cost of Living Increases?

If you’re a federal retiree, good news! Your federal pension has cost of living adjustments (COLA) built into it. Your payouts will increase over time. Now, will those increases keep up fully with inflation? Probably not. But they will go up incrementally over time.

Recipients of Social Security also get cost of living increases. Will those increases keep up with inflation? It’s doubtful. We routinely hear people complain, “I got a raise in my Social Security—but the cost of my Medicare went up so much, I didn’t see any difference!”

Our counsel is to be thankful for any cost-of-living increases you get but do your part too. You want to plan, save, and invest in such a way that you have the financial means on hand to handle any future increases in living costs. 

Taxes: The Second “Enemy of Retirement”

The second enemy in retirement is taxes

In recent years, conventional wisdom has been: “Put money in your traditional TSP, IRA, or 401(k). Don’t pay taxes on that money now, while your income and tax bracket are higher. Instead, wait until you retire—when your income is less. Pay taxes then. You’ll have a lower tax bill!” 

The advice sounds good, but what we’ve seen is that many federal retirees have wonderful, robust pension plans. When they retire, it turns out that their income doesn’t drop very much. They’re drawing a pension and receiving Social Security and tapping into other assets. All that income adds up.

Consequently, some retirees end up paying taxes at a very similar rate, sometimes even more than they paid while they were working! 

To address this tax problem, we need to wrestle with two questions:

  1. Societally, will taxes be lower in the future?
  2. Personally, will your taxes be lower in the future? 

Taxes: What can the past tell us about the future?

Let’s review the top marginal tax rates over the last 80 years.

From the mid-1940s to the early 1960s, the maximum tax rate hovered around 90%! (Can you imagine?) By the 1970s, the top bracket had dipped some, but it was still high, around 70%. 

Quick story: In those years, a certain Hollywood actor decided he would only make two films a year. That was because he made $100,000 per movie and once his earnings exceeded $200,000, he found himself in the uppermost tax bracket. By the time he paid California state income tax, he had almost nothing to show for his work! That actor? A man named Ronald Reagan. 

In 1980, when Reagan was elected President, he worked with Congress to lower tax rates from around 70% to around 30%. Today the highest tax bracket stands at 37%.

So, historically speaking, we could say taxes are on the lower end today. But if you ask, “How are taxes?” most people complain. As to what politicians will do in the future, that’s anyone’s guess.

Taxes: What about your future?

People worry about the growing national debt. What can the government do to make that debt more manageable as we keep racking up trillions and trillions in new spending? 

Ironically, inflation is one tool the government uses, and taxes are another. The very two enemies we’ll face in retirement are the primary means the government has to try to keep the debt in check! Given that fact, we have to ask: During your 20, 30, or 40-year retirement, do you think tax rates are likely to go up…or down?

If tax rates are headed up, then contrary to popular belief, paying taxes on your money now instead of later might actually be the smarter move. (NOTE: Again, this isn’t tax advice for you to act upon today. Always consult a tax professional on such matters. But what we can say in general, is that if taxes go up, many people will be paying more down the road.

It’s smart to analyze what your income and tax rate are today, versus what they might hypothetically be when you retire.

The goal is to get your lifetime tax bill as low as it can be. That means you may wish to pay some taxes now on a smaller balance instead of paying a potentially higher rate later on a potentially larger amount

Taxes: The Power of Roth (and Roth conversions)

With a traditional IRA or TSP, you don’t pay taxes now, you pay later—when you pull the money out in retirement. With a Roth IRA, however, you pay taxes now and don’t have to pay later. Think about it like this: Would you rather pay tax on the small seed that you plant in the ground or on the big harvest that comes up later? 

Therein lies the power of Roth. You pay taxes on the initial amount, but then you get all the proceeds tax-free. 

And here’s more good news: You can convert money from your traditional IRA into a Roth IRA. How does that work? You take the money in your traditional IRA and go ahead and pay taxes on it now. Then you put that money into a Roth account where it can grow tax-free (as long as you follow the regulations that govern Roth accounts). 

Again, this isn’t tax advice. Before doing this, you’d need to discuss with your CPA the tax ramifications—now and later—of such a move. But, bottom line, a Roth conversion can help lessen the amount of taxes you’ll pay in retirement. 

Here’s another potential surprise: Many people don’t know that their Social Security benefits can be taxed if their total retirement income—pension money + Social Security + any withdrawals from a traditional IRA or TSP—exceeds a certain amount. Not only that but if your income exceeds a certain limit, you’ll have to pay more for Medicare. (That extra Medicare premium can be substantial.)

That’s the beauty of a Roth IRA. All money withdrawn from a Roth account is non-taxable. Since it’s not considered income, it won’t raise your taxes. 

It’s important to think hard about the enemy of taxes in retirement, but you also need to be careful. To save on taxes later, you might want to pay more in taxes now. Consider all the factors. Our best counsel? Seek the help of an expert. 

A few final reminders and thoughts.

Let’s define a few terms and clarify a couple of points so no one is confused. 

  • Roth contribution is you writing out a check from your checking account to a Roth account. 
  • A Roth conversion is taking money from a traditional IRA, paying taxes on it now, and moving it into a Roth account. NOTE: Your tax situation will dictate how much you can afford to do each year in Roth conversions. Remember: When you convert money like this, the IRS regards that amount—whatever it is—as income for the year in which you do it. Convert too much and you’ll find yourself in a higher income/tax bracket.
  • In retirement, if you don’t have earned income, you can’t do Roth contributions anymore, but you can do a Roth conversion—up to any amount that you want. 
  • The TSP won’t let you do a Roth conversion. So, what can you do? Either at retirement or at age 59 and a half, you can start moving money out of your TSP into a regular IRA. Then you can do a Roth conversion from there.

We can’t help retirees (or soon-to-be retirees) with vacation planning or pickleball injuries, but if you have questions about heading off inflation or reducing taxes in retirement, we’re here!

About the Author

Mel Stubbs is a Financial Planner and educator at Christy Capital who works with federal employees all over the country, teaching them how their retirement system works and how to plan for retirement using their available benefits.