How do I hedge inflation for a non-COLA pension

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
Posts: 79
Joined: Thu Aug 06, 2020 8:46 am

How do I hedge inflation for a non-COLA pension

Post by humblecoder »

Good day all. I've been on this message board for a few weeks and let me say that I have learned a lot from everyone here. I thought that I was pretty knowledgable when it comes to investments and money, but reading the posts and wiki here is like a master class!

Anyway, I have a question for the masters out there.

When I retire, I am going to be one of the lucky few who will have a defined benefit pension (and from a private sector company, no less!). However, it is non-COLA, so while it might look good in year 1, by the time I get to year 30, it is possible that it might only have half of its spending power. I want to know if there are SPECIFIC actions that I can take in order to insure my pension against inflation.

I know that everybody likes hard numbers, so here we go:

PLANNED RETIREMENT AGE: 56 y.o (I am married and my wife is one year younger, if that matters)
PENSION: $45K/year, non-COLA

I plan to use a withdraw rate of 3% following the "Trinity Study" methodology. That is, take out $45K in the first year, $45K + inflation adjustment in the second year, etc.

I also plan to keep my asset allocation at 60/40 in retirement (with 60% of equities in US and 40% in int'l) using the three-fund portfolio principles.

My wife will continue working part time until claiming SS and I will likely not work and care for our disabled daughter.

Between the pension, retirement savings withdrawals, part time work, and SS, that should cover our expenses.

The twist, however, is that the pension is fixed without any COLA. That means that the real value of pension is going to go down over time. My thought is that in addition to increasing our withdrawal by inflation, we would also withdraw enough to make up for the pension inflation shortfall. For instance, if in year 2 inflation is 2%, I'd withdraw $45,900 based upon the normal Trinity Study methodology and then an additional $900 to make up for loss of purchasing power of my pension.

When I run this through FIRECalc, it shows that this will work with 95%+ success, which makes me feel better. However, is there any specific that I should do just to insure for the high inflation scenario?

Here are my thoughts:
1. I am already planning on a 60% asset allocation in retirement, so hopefully, that will provide enough inflation protection. However, hope is not a strategy. Should I be even more aggressive?

2. The other obvious answer is to hold TIPS and/or I-Bonds. However, is there is specific amount or laddering strategy that would be guaranteed to provide inflation protection for my $45K/year pension? I could buy $45K of TIPS each year in retirement and the interest would cover the inflation buying power shortfall. However, after 30 years of this, I'll have a crap ton of TIPS!

I'm sure there is some easy, obvious answer that I am missing and once I hear it, I'll be like "duh". :happy
Posts: 33842
Joined: Sun Mar 04, 2007 9:50 am

Re: How do I hedge inflation for a non-COLA pension

Post by dbr »

The only protection of this income stream is for other sources of income to increase faster than inflation.

For one thing TIPS, which are compensated exactly equal to inflation, don't do this by definition. One might say TIPS are hedged for inflation but are not a hedge for the inflation of other things.

The usual "4%" rule is designed around increasing withdrawals by inflation, but in the presence of significant fixed income that whole model does not apply. The portfolio withdrawals have to increase faster than inflation to keep up.

But, have you noticed FireCalc is smarter than that. The program does not set portfolio withdrawals at a fixed real amount but rather adds everything in, some of it fixed nominal and some of it possibly inflated, and looks at what comes out in the wash. So if FireCalc is giving you success that is about as good as you are going to get in general. Note in the basic model FireCalc does not use an estimate for inflation but uses past actual values. There are options to put in your own estimates. In general low withdrawal rates like 3% have been so robust that neither inflation nor asset allocation matter. When withdrawal rates are pushed higher there is a mild optimum asset allocation at around 50/50 to 60/40, but the only serious mistake is to let stock allocation go far below about 40%.

A different answer is that there aren't many perfect hedges for inflation. One approach that does this is to provide retirement income from a TIPS ladder where each year's income comes from redeeming the step of the ladder that matures that year. Such a scheme has no duration risk because the bond is redeemed at maturity and it has no inflation risk, or course. The scheme does have longevity risk, because when the last bond is redeemed you are broke. A TIPS ladder is also expensive. At the current real yield of 30 year TIPS at -0.5% or worse the withdrawal rate is only 3.1%. In this sense the ladder scheme is still at risk to low interest rates, but you can see what you are going to get from the start.

A better perfect hedge for inflation is an inflation indexed annuity. Those don't exist on the market anymore though one might hope for a pension with those terms, maybe. That does bring up that Social Security is an inflation indexed annuity which can be maximized by delaying SS until age to age 70.
Posts: 167
Joined: Mon Jul 11, 2011 11:38 am

Re: How do I hedge inflation for a non-COLA pension

Post by Breezy »

To me, the overall rate of inflation is less important than MY personal rate of inflation. In the short term, it's easier to plan around, too. For instance, it's easier for me to decide that in the first three years of retirement, I will spend (for instance) $35,000/year from my retirement accounts. I can see that far ahead, and decide what to do for the next few years beyond that sometime while in the middle of it.

The truth is, lots of expenses have lots of leeway to them. You can keep a car an extra few years or lease expensive ones every three years. You can drive to a vacation destination or fly first class. Neither is wrong if you have the money to pay for it, but there are lots of choices that you will make long the way. So there's inflation & expenses you can control, and other ones you have less control over. Health care and dental care come to mind.
Posts: 279
Joined: Wed Jan 07, 2015 3:45 pm

Re: How do I hedge inflation for a non-COLA pension

Post by WS1 »

Do you mean how do I save in preparation for collecting a non-cola pension or what do I do while receiving a non-cola pension? If it's the latter, I vaguely remember reading, maybe here but I don't know, Live on 85% of the non-cola pension and put 15% stocks
Posts: 2781
Joined: Mon Mar 02, 2009 8:00 pm

Re: How do I hedge inflation for a non-COLA pension

Post by rgs92 »

The $45,000 pension is about $3,750 a month in a fixed annuity for life (an SPIA). The SPIA will cost $100,000 for each $500/month income.
Therefore, since $3,750 is 7.5 times $500, you would need $700,000 to generate your pension.

So your pension is worth that $700,000, and you could take 4% of this each year and increase for inflation, or $28,000.
So you can consider that you have that $28,000 a year inflation adjusted. (Which is $2,333 per month.)

So just spend $28,000 a year of your pension, increase it each year for inflation, and put the remainder in a 60/40 stock/bond portfolio, like a 3-fund-portfolio.
Posts: 294
Joined: Fri Jun 29, 2018 4:31 pm

Re: How do I hedge inflation for a non-COLA pension

Post by carmonkie »

There is a CD ladder thread on retirement and user unbiased posted the following link:

You might want to check it out. But in short talks about creating a CD ladder with 75% cash and about 25% in VTI.
Topic Author
Posts: 79
Joined: Thu Aug 06, 2020 8:46 am

Re: How do I hedge inflation for a non-COLA pension

Post by humblecoder »

Thanks for the interesting thoughts.

I did consider the "spend less and invest the rest" strategy, but to do that, I'd likely have to make up the income somehow, presumably by withdrawing more from my retirement assets. So it essentially becomes a wash versus my plan to withdraw extra each year to pay the COLA increase out of my own assets.

Regarding adjusting my spending in response to high inflation, I agree that there are levers that I could pull. However, many of the levers aren't within my control as you point out. But definitely an option should it come to that.

Anyway, it doesn't sound like there is a clean out of the box solution to DIY a COLA rider for my pension, other than just making sure that my retirement assets are investing such that they will be able to grow if inflation grows.
Posts: 6357
Joined: Sun Apr 25, 2010 7:42 pm

Re: How do I hedge inflation for a non-COLA pension

Post by Dandy »

Some suggestions:

1. Try to wait to age 70 to collect SS. Better for you and your spouse assuming you are the higher wage earner.
2. Withdraw based more on need vs an automated increase in withdrawal amount.
3. Your equity allocation should, over time, offset some inflation
4. Consider a decent allocation to one of the Inflation Protected Securities Funds as part of your fixed income
Post Reply