Two big risks in retirement are inflation and poor market returns, and in this article I’ll discuss how income layering can help cover those risks

Inflation is an often overlooked risk to a successful retirement, but that’s not surprising given that inflation has remained low for some time. Over the past 15 years, inflation has averaged about 2%, well below its historical averages. If we widen the timeframe to 40 years, the average inflation rate jumps to a bit above 4%.

That may not sound like a large difference, but it is.

At a 2% inflation rate, expenses double every 36 years. At 4% inflation rate, they double every 18 years.

If you are planning on retiring and living on $80,000 per year you would need roughly $160,000 in 18 years based on 4% inflation, but just under $110,000 if inflation averaged 2%. The impact of inflation is even larger over longer timeframes, so suffice it to say, inflation can have an outsized impact in retirement.

The good news is that if you are retiring on FERS, both the FERS annuity and your Social Security have cost of living adjustments. The downside is that once inflation rises above 2%, the cost of living adjustment for the FERS annuity does not keep up with inflation and the adjustment can be as much as 1% below inflation. Every year the FERS cost of living adjustment falls below the inflation rate, you lose a bit of spending power, so if there is an extended period of inflation in retirement, it can seriously erode the value of the FERS annuity.

Whether or not this is a real risk to you in retirement depends upon a number of factors. If it is a risk one way to address the possibility of inflation is via your TSP account as well as any other invested assets. Over a long-term timeframe, a well diversified portfolio that includes both equity and fixed income will generally earn a return that outpaces inflation – and thus provides you with growing spending power to help offset the potential loss of spending power from the FERS annuity.

The downside to investing in a portfolio is that returns – particularly over the short-term – are uncertain. By combining the guaranteed income of the FERS annuity and Social Security with income from a diversified portfolio that should provide a higher return over time, you address both inflation risk and market return risk.

We refer to this approach as income layering

By examining your retirement needs along with all your sources of retirement income and your investable assets, we can help you determine how to layer income in retirement. When, for example to begin drawing social security and whether to roll over the TSP account to an IRA or purchase a life annuity with the proceeds.

Viewing retirement planning through the prism of income layering allows you to combine your income in such a way that you can address the financial risks you’ll encounter in retirement.




1 – One notable exception when it comes to inflation is medical expenses – they have grown at a rate that is a good deal higher than the rate of inflation, so we separate out medical expense in retirement planning for clients.

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