• OnTarget Masthead
  • Mort Reinhart
  • Use Your Tax-Sheltered Annuity to Create Your Own Cost-of-Living


    While the suspension of cost-of-living adjustments for all current and future retirees (Chapter 78) has a draconian effect on those who have been retired for many years, new retirees might be able to provide a personal “cost-of-living” adjustment for themselves by using their tax-sheltered accounts wisely in one of two ways.

    If a retiree tracks the national Consumer Price Index as reported each year in January, she can withdraw an amount each year equivalent to the rise in the CPI to supplement her pension. Using the example above of a pension of $61,672 and assuming an inflation of 2% in her first year of retirement, our retiree can withdraw $1,233 (2% of $61,672). Her second year pension would then be $62,905 ($61,672 plus $1,233 = $62,905), thereby negating the effect of inflation. The following year, with inflation rising 1.5%, she can withdraw $943 (1.5% of $62,905) from her tax-shelter and add that to her $62,905, making her income the next year $63,848 ($62,905 plus $943 = $63,848). Following this method each year in the future provides the retiree with a compounded personal “cost-of-living” adjustment and permits her to try to keep up with inflation.

    The second way to try to keep up with inflation uses the same method, except that the adjustment is always based on the original pension. In this scenario, the percentage of inflation adjustment each year uses the original $61,672 to calculate the dollar amount. The first year with 2% inflation would be calculated in exactly the same manner as above (2% of $61,672), resulting in a pension of $62,905. In the second year, using the 1.5% inflation rate, the amount of the withdrawal would be $925 (1.5% of the original $61,672), making the next year’s pension $62,597. The following year’s calculation would still use the original pension of $61,672 as the basis for the percentage of adjustment. This method does not have the compounding effect of the first method, but is another way of providing some personal “cost-of-living” adjustment. The Division of Pension and Benefits used a similar method with a slight twist (increasing the original pension each year by a factor) when the state was providing cost-of-living adjustments to retirees prior to Chapter 78.

    It should be noted that the longer the retiree lives, the larger the amount that will have to be withdrawn from the tax-shelter each year.  

    Sadly, for those who retired many years ago without the benefit of tax-sheltered savings and who need the cost-of-living adjustment most, the ability to provide a personal “cost-of-living” is limited. For them, Chapter 78 was devastating.