Price inflation threatens the standard of living that can be supported by your Thrift Savings Plan account over time. In order to maintain your income\u2019s buying power, you\u2019ll need to increase the nominal, or actual dollar, amount of your withdrawals over time to compensate for increases in the cost of living.<\/p>\n\n\n\n
Accounting for inflation is one of the obstacles that make managing a TSP account difficult or impossible for too many participants. Unfortunately, the TSP does little to help you with this. Among other shortcomings, their calculators do not offer the option of adjusting withdrawals for inflation. This makes these calculators potentially dangerous planning tools. It\u2019s difficult to find analytic systems elsewhere that will handle the calculations necessary to account for inflation in your retirement planning. In fact, it\u2019s so difficult that I\u2019ve spent years building an perfecting my own.<\/p>\n\n\n\n
It might seem reasonable to assume that if you start with $100,000, invest it at a 4 percent annual rate of return and begin taking withdrawals of $4,000 per year, the income will last forever without the need to invade the principal. You will simply withdraw the $4,000 that you have earned each year, for as long as you live, and then leave the remaining $100,000 as part of your estate.<\/p>\n\n\n\n
This will work, of course, but at a significant, often overlooked, cost: that of inflation. If inflation averages 2 percent, the buying power of that $4,000 annual withdrawal will be cut in half over 35 years. Looked at another way, if the $4,000 withdrawals are adjusted for inflation at 2 percent, against an investment return of 4 percent per year, the account will be empty in 36 years.<\/p>\n\n\n\n
Raise the annual inflation rate to 3 percent and the buying power of the withdrawals will be cut in half in only 25 years and the account will be empty in 30 years.<\/p>\n\n\n\n
In addition, FERS annuitants need to account for the fact that their annuity income is not intended to keep up with inflation. In order to maintain a level standard of living, additional withdrawals will need to be taken from the TSP to make up for the gradual loss in purchasing power of those annuity payments.<\/p>\n\n\n\n
So, not only do you have to account for inflation in your cost of living over time, but you might also, and at the same time, have to account for the declining purchasing power of your FERS annuity \u2014 or other retirement income that doesn\u2019t come with full cost-of-living adjustments. While the effects are not easy to account for in a retirement plan, they are not impossible to handle. The first step is to make sure that they aren\u2019t overlooked entirely.<\/p>\n\n\n\n