Retirement Budgeting in a 3% Inflation World

That 3% inflation “feels small”…until you do the math

That 3% inflation “feels small” when you hear it on TV. It isn’t small when you do the math that actually determines whether your retirement budget holds up. The quick rule I still keep on a sticky note: the Rule of 72. Divide 72 by the inflation rate. At ~3% year over year, prices double in about 24 years. That’s within a normal retirement. Which means a $75 grocery run earlier this year? Late in life it’s roughly $150-$160, even if you buy the exact same cart. No drama, just compounding quietly doing what compounding does.

Two things are true at once right now. First, headline inflation has cooled from the peaks we all remember, and according to BLS releases, CPI has hovered near around 3% year-over-year for chunks of 2025. Second, your personal inflation is not the headline number. The 2025 Social Security COLA is 3.2% (announced last year), which helps, but healthcare, housing, and property insurance can run hotter than the average basket. I’m not guessing, retirees routinely report higher medical and shelter costs than the overall CPI. That mismatch is where budgets crack.

Fast math: 72 ÷ 3 ≈ 24 years. Your purchasing power halves roughly every 24 years at 3% inflation. In a 30-year retirement, you’re fighting a near halving and then some.

Here’s the part people miss while they stare at next month’s prices: sequence of returns risk plus compounding inflation is the one-two punch. It’s not year-one prices that break a plan; it’s taking withdrawals after a rough market patch while your costs trend higher every single year. Pull out too much after a down year and you’ve locked in losses. Then inflation keeps nudging your spending up. Rinse, repeat, and the math gets unforgiving.

And yes, cash yields have been better than the near-0% era, which helps with short-term reserves. But you can’t CD-ladder your way through three decades of 3% inflation without growth assets doing some heavy lifting. I say that as someone who loves a good T-bill, maybe too much. The goal isn’t maximum return; it’s maintaining purchasing power without taking more risk than your stomach can handle.

What you’ll get from this piece isn’t a magic spreadsheet. It’s a practical way to reframe “low” inflation as a budget compounding problem you must actively manage in 2025 and beyond:

• How to translate the Rule of 72 into real-dollar spending targets (yes, for groceries, utilities, and Medicare premiums, more on that in a second).
• Why the 3.2% COLA is helpful but not a free pass if healthcare or housing are running hotter than headline CPI.
• Portfolio tactics to reduce sequence risk while keeping enough growth to outrun that steady 3% headwind.
• Simple guardrails to keep your withdrawal rate flexible when markets wobble, because they will.

I know, it sounds obvious. But obvious things get ignored. 3% is quiet. It’s polite. And over 20-30 years it’s the difference between a plan that breaths easily and one that’s constantly short by, say, around 7% of what you thought you had. I’ve seen both kinds. One more quick note: there’s nuance here, and some of the data is messy. When I’m not certain, I’ll say so. Better honest guardrails than perfect-sounding guesses.

Build the retirement budget that can go the distance (not just year one)

A 3% inflation world doesn’t need heroics, it needs structure. Start by splitting spending into three buckets that you can actually manage in real time:

• Essential (non-negotiable): housing, utilities, food, insurance, basic healthcare, taxes.
• Flexible (can shift timing/scale): travel, dining out, hobbies, gifting, upgrades vs. repairs.
• Discretionary (nice-to-haves): big trips, luxury gear, premium add-ons.

Then give yourself a glide path. When markets are rough, plan to trim 5-10% from discretionary for a year or two. That’s your shock absorber so you’re not selling assets at bad prices. And yes, you pre-decide this cut so you don’t debate it in the middle of a selloff. With rates still elevated and equity volatility not exactly shy in 2025, this buffer matters.

Model healthcare realistically. It often grows faster than headline CPI. CMS’ National Health Expenditure projections (released in 2024) show U.S. health spending growing about 5.6% per year on average from 2023-2032. That’s a decent proxy for a long-run health-cost growth rate. I typically budget premiums + out-of-pocket at CPI + 2% or a straight 5-6% nominal, then adjust annually with your actual claims and plan changes. It’s not perfect; it’s honest. Also, Medicare premiums can jump in odd years; don’t anchor on a single-year print.

Include housing’s stealth inflation. Even if the mortgage is gone, the house still eats. Insurance and property taxes can run hotter than CPI. One broad datapoint: homeowners insurance premiums rose about 23% from 2021 to 2023 nationally (Bankrate analysis, 2023). That’s not every zip code, but it’s a wake-up call. For upkeep, I set a placeholder at 1-2% of home value annually for maintenance, rising with construction/labor costs. Roofs don’t care about your budget spreadsheet.

Create sinking funds for lumpy costs. Cars, roofs, and big trips shouldn’t blow up your annual plan. Example:

• Car: replace every 8-10 years; set aside 1/8-1/10 of the target cost per year, plus 3% inflation.
• Roof/HVAC: estimate remaining life; divide replacement cost by years; add to annual “house” line item.
• Big trip: plan a $12,000 trip every 3 years? Save $4,000 per year into a travel fund, growing with CPI.

Rule of thumb I actually use: if it’s over $2,000 and happens less than annually, it’s a sinking fund line, period.

Hold 1-3 years of essential expenses in cash/short‑term Treasuries. That cash bucket keeps you from forced selling when markets drop. And the carry isn’t terrible right now: short-term Treasuries have spent much of 2025 in the 4-5% yield range. Use a ladder (T‑bills/short bond funds) for the next 12-36 months of essentials; refill it from portfolio gains in good years.

Pulling it together, your spreadsheet should show each category with its own growth rate: essentials at ~3%, healthcare at 5-6%, housing maintenance at 1-2% of home value with inflation, and discrete sinking funds. It sounds fussy, I know. But this is exactly what lets your budget flex instead of break. And if I’m being picky, yes, some years you’ll tweak the dials. That’s the point. Better a living plan than a fragile one that looks tidy and then cracks the first time insurance jumps 12%.

Withdraw smarter: guardrails beat one-and-done rules

Withdraw smarter: guardrails beat one‑and‑done rules. Fixed rules feel clean, but retirement income lives in the gray. The famous 4% rule (Bengen, 1994) was a helpful starting story, not a forever law. Conditions change, yields, valuations, your spending, taxes. Morningstar’s 2023 work, using more conservative assumptions, put the 30‑year starting “safe” rate closer to 3.8%. Call it what it is: a base rate, not a promise.

Reference point: Morningstar (2023) estimated a ~3.8% initial withdrawal rate for a 30‑year horizon under conservative return and risk assumptions.

Here’s how I set it up this year for real clients and for my own sanity. Start with a base, around 3.5-4.0%, then use guardrails to steer. Markets breathe; your plan should too.

• Guardrails (Guyton‑Klinger style): If your portfolio rises or falls by about ±20% from the last high‑water mark, adjust spending. Up 20%? Grant yourself a raise (no need to be heroic, maybe half the inflation bump). Down 20%? Trim by 10% or so and skip the cost‑of‑living raise. Not forever, just until the portfolio recovers.
• Dynamic inflation raises: After a down year, pause the raise. When you get back to a new high, restore inflation increases. It’s the same idea said two ways: protect in bad times, participate in good times.
• Cash‑flow matching for essentials: Build a 7-10 year Treasury/TIPS ladder to cover non‑negotiables, housing, food, healthcare. With 10‑year TIPS real yields hovering around ~2% for much of 2025 and short Treasuries yielding 4-5%, the carry isn’t terrible. This reduces sequence risk because you’re not selling stocks at fire‑sale prices to pay the electric bill.

I like to visualize it in three buckets: cash/TIPS for the first decade of essentials, a diversified core (stocks/bonds) for growth and discretionary spending, and a “risk” sleeve you only touch when markets cooperate. Imperfect? Sure. But adaptable beats brittle.

Taxes, this part is where money is quietly won or lost. Coordinate withdrawals across taxable, traditional, and Roth accounts so you fill, but don’t blow through, your target bracket and avoid surprises with Medicare IRMAA. IRMAA surcharges kick in when your modified AGI crosses the thresholds; a big one‑time IRA pull or capital gain can tip you over and hike premiums by what feels like around 7%, and you don’t get a do‑over. In practice:

1. Harvest from taxable first (basis recovery, manage capital gains),
2. Top off the desired ordinary bracket with traditional IRA withdrawals or conversions, especially while the current rate schedule is still in place this year,
3. Use Roth as the shock absorber in bad markets or to keep MAGI below IRMAA cliffs.

Bottom line: set a sensible starting rate, add guardrails, and backstop essentials with a ladder. Repeat the mantra when markets get noisy, protect when it hurts, participate when you can. Intellectual humility helps here; rules are great until reality shows up. Then you tweak, you adapt, you keep the plan living.

Inflation buffers that actually belong in retiree portfolios

Not every “inflation hedge” maps to how retirees actually spend. You’re buying groceries, paying property taxes, traveling a bit when the grandkids are free, those are CPI-like costs, not gold miner costs. Keep it simple, liquid, tax-aware, and match the tool to the bill it needs to pay. 2025 hasn’t changed that. The market’s telling you something, too: the 10‑year breakeven inflation rate has hovered in the mid‑2% range this year, so price the problem you have, not the one on cable news.

TIPS and TIPS ladders: direct CPI linkage. Treasury Inflation‑Protected Securities adjust principal with CPI-U. That means your real spending power is the thing you’re securing. Right now, with the 10‑year breakeven sitting mid‑2%s in 2025, compare your TIPS real yield to that breakeven to sanity‑check nominal bonds. If a 10‑year TIPS yields ~2% real and the breakeven is ~2.3-2.5%, the implied nominal 10‑year is ~4.3-4.5%, rough math, but it keeps you honest. The simple retiree play: build a TIPS ladder maturing each year to fund essential expenses for, say, the next 8-12 years. You lock real dollars and stop arguing with inflation. Minor tax note: TIPS in taxable throw off taxable inflation accretion; they’re cleaner in IRAs, or use a TIPS ETF and live with distributions.

I Bonds: tax‑deferred inflation protection. Boring, effective. The annual purchase limit is still $10,000 per person as of 2025 (plus up to $5,000 via a tax refund). Interest accrues and defers until redemption, which lets you time income around IRMAA and bracket goals. These are illiquid for 12 months and you forfeit three months’ interest if you cash out before five years, so think of I Bonds as the “middle shelf” of the cash/collars/TIPS pantry, not the emergency drawer.

Short‑duration, high‑quality bonds: fund near‑term cash needs. This is the cash bucket that actually earns something. With the curve still offering decent yields at the front end this year, a 0-2 year ladder of Treasuries, agencies, or an ultra‑short fund reduces rate sensitivity while covering the next 2-3 years of withdrawals. That time segmentation, cash/short for years 1-3, TIPS ladder for years 4-12, diversified risk assets beyond, keeps you from selling stocks into a downdraft just to pay property taxes. I’ve done that rebalance on a bad tape; it never feels good.

Dividend growers: helpful, not perfect. Companies that raise dividends can help your spending keep up over time, but it’s lumpy and not a guaranteed CPI match year to year. Some years the dividend growth is 8%, other years boards get cautious and it’s 2%, and occasionally someone cuts. Use them as a complement to TIPS, not a substitute. TAX NOTE: qualified dividends are tax‑friendly in taxable accounts, but watch how they stack with RMDs; I’ve seen “nice” dividend increases shove people over an IRMAA cliff by a few hundred dollars of MAGI, which is… annoying.

SPIAs or DIAs with inflation adjustments. If you want to transfer longevity risk and secure a floor, single premium immediate annuities (SPIAs) or deferred income annuities (DIAs) can do the job. You can buy versions with fixed COLAs or CPI‑linked adjustments, but COLA riders raise costs and lower initial payouts, shop carefully across carriers and compare internal rates of return versus a TIPS ladder for the same cashflows. One more practical bit: partial annuitization often works best, cover utilities, basic food, property tax, Medicare premiums, let markets handle the discretionary stuff we’ll talk about later.

Simple rule of thumb: inflation‑match essentials with TIPS or annuity COLAs; use short‑duration bonds to bridge; let dividend growth and equities handle wants, not needs.

Pulling it together. If your “retirement-and-budgeting-in-a-3-inflation-world” plan aims for real spending stability, anchor the first decade with a TIPS ladder and a 2-3 year short‑term bond sleeve, add I Bonds annually up to the $10k cap, and layer dividend growers for long‑run growth. Keep your tax lenses on: TIPS in tax‑deferred, I Bonds for deferral, qualified dividends in taxable, and watch MAGI in Q4 when RMDs and capital gain distributions hit, because yes, that’s when IRMAA letters seem to show up. It’s not flashy, it’s not perfect, but it maps to the bills you actually pay; and that’s the entire point.

Taxes, Medicare, and the 2025 sunset clock

. Here’s the real calendar item on the fridge: 2025 is the last full year before many individual pieces of the 2017 Tax Cuts and Jobs Act expire after December 31, 2025. That means one more tax year with wider brackets and a bigger standard deduction before potential 2026 resets. Not a scare tactic, just math. The window is narrow for Roth conversions, bracket topping, and estate housekeeping. And yes, the Medicare/ACA calendars don’t line up with tax season, which is where avoidable surprises live.

Roth conversions and bracket management. If you’re sitting in the 12% or 22% brackets this year and expect to be in a higher bracket later, filling those 2025 brackets with conversions can be worth it. Coordinate with capital gains work: last year (2024), the 0% long-term capital gains bracket ran up to $47,025 taxable income for single filers and $94,050 for married filing jointly (IRS, 2024). The exact 2025 thresholds are indexed, but the planning idea is the same, stack conversions and gains deliberately so you don’t accidentally bump one with the other. Small thing that’s not small.

RMDs, QCDs, and beneficiaries. SECURE 2.0 (enacted 2022) set the RMD age at 73 now, moving to 75 in 2033. If you’re 70½ or older, Qualified Charitable Distributions can send money directly from an IRA to a charity and keep it out of Adjusted Gross Income. The annual QCD cap is indexed; it was $105,000 per person in 2024 (IRS). That’s real money and it reduces future RMD size. Also, clean up beneficiary designations while the estate exemption is still high: in 2024 it was $13.61 million per person; it’s scheduled to fall by roughly half in 2026 under current law. The anti‑clawback regs (IRS, 2019) confirm you won’t be penalized for using the higher exemption now, use it or potentially lose it.

Medicare and ACA timing quirks. Medicare’s IRMAA surcharge uses a two‑year lookback. 2025 premiums are based on your 2023 MAGI. So a chunky Roth conversion done in 2023 might be why you saw a bigger Part B number this fall. Manage 2024-2025 conversions with that lag in mind. For pre‑Medicare retirees on ACA coverage, the Inflation Reduction Act extended enhanced subsidies through 2025, which removed the old 400% of FPL “hard cliff”, but higher MAGI still shrinks your premium tax credit quickly. In non‑expansion states, dipping below 100% FPL can be its own problem. Point is, taxable income you pull for conversions or capital gains harvesting can swing premiums.

Asset location still matters. With cash and short bonds still yielding more than the pre‑2022 era this fall, shelter tax‑inefficient fixed income inside IRAs/401(k)s when you can, and save Roth space for high‑growth assets or for late‑retirement spending. It’s a bit simplified, I know, but directionally right: defer what throws off ordinary income; protect what you want compounding tax‑free the longest.

Plan like it’s 2025, because, well, it is: fill lower brackets now, mind IRMAA’s two‑year lookback, and let QCDs and beneficiary cleanup reduce future RMD pain.

• Map your 2025 bracket headroom before year‑end; model conversions plus any capital gains distributions hitting in Q4.
• If age 70½+, price a QCD against itemizing, you don’t need to itemize to benefit from a QCD.
• Age 63-65? Model how 2025 income affects 2027 Medicare premiums; keep notes.
• On ACA before 65? Track MAGI vs. FPL bands monthly; avoid big, late‑year surprises.
• Review estate documents and beneficiary designations while the higher exemption is still in place; consider lifetime gifts if that fits your plan.

And if this feels like too many calendars at once… you’re not wrong. I keep a nerdy spreadsheet because I’ve been burned by a stray year‑end mutual fund distribution before. Twice, actually.

Alright, now the playbook: one year at a time

This is the boring part that actually builds wealth. A simple 12‑month cadence you can run every year, even if inflation bumps around 3% and markets keep being… well, markets. I’m doing a version of this myself because good habits beat heroics.

• January-March: close the books on last year’s spending. Update actuals, not vibes. Reset sinking funds for big irregulars (home, auto, travel, insurance deductibles). Set a provisional withdrawal rate for the year, start from your essential budget, add discretionary with a haircut tied to market level. With T‑bills yielding around 5% earlier this year, there’s no shame keeping 1-3 years of essentials in cash/short Treasuries; it calms nerves and reduces forced selling.
• Quarterly: run a quick rebalance with bands (for example, ±5% around target). If equities ran, trim back and refill the 1-3 year cash bucket from appreciated assets. Vanguard research has long shown band‑based rebalancing (e.g., 5% thresholds) contains drift without constant tinkering, low maintenance, high adherence. Keep it mechanical.
• Mid‑year check (June): estimate year‑to‑date MAGI. Compare against Medicare IRMAA tiers and your Roth conversion plan. Remember IRMAA’s two‑year lookback: 2025 premiums use 2023 MAGI. For context, in 2024 the first IRMAA threshold was $103,000 single / $206,000 married filing jointly (CMS). If you’re pre‑65 on the ACA, match MAGI to your chosen Federal Poverty Level band; the enhanced subsidies under the American Rescue Plan/Inflation Reduction Act remain in place for 2025, and many households see $0 benchmark premiums near 150% FPL. Decide on partial Roth conversions now, fill lower brackets, don’t blow through an IRMAA tier by accident.
• Fall (Oct-Nov): benefits season. Review Medicare Part D and Advantage formularies; premiums and drug tiers move every year. Adjust your 12‑month medical budget to the new premiums and expected out‑of‑pocket. Small note: I think it was 2018 when I skipped this step, pretty sure, and a formulary change cost me a few hundred bucks. Annoying lesson learned.
• Year‑end tidy‑up: harvest gains or losses deliberately. You can offset up to $3,000 of ordinary income with capital losses if losses exceed gains (IRS cap that hasn’t moved in years). Confirm your charitable plan. If age 70½+, qualified charitable distributions (QCDs) can go directly from IRAs to charities and keep adjusted gross income lower; the indexed QCD limit was $105,000 per person in 2024. Also harvest in the 0% long‑term capital gains bracket if you qualify; in 2024 that bracket topped out at $47,025 taxable income for singles and $94,050 for married filing jointly (IRS). Finally, lock in next year’s essential‑expense ladder, T‑Bills, CDs, or short Treasuries to cover the first rungs.

A couple of guardrails that help the whole year hang together:

• Spending dial: essentials are fully funded; discretionary flexes with markets. If stocks are down 15%, pull back travel/dining by, say, 10% and skip the car upgrade, simple, predictable.
• Tax dial: trend AGI down over time. QCDs where eligible, bracket‑filling Roth conversions, gains in the 0% bucket when opportunity appears. Keep notes, your future self won’t remember the why.

Success here is boring on purpose: your essentials are funded, your discretionary adjusts with markets, and your taxes trend lower over time, even if inflation hangs around ~3%. It won’t be perfect every year; the cadence makes the wins repeatable. And if you miss a quarter? Don’t sprint. Just pick up the checklist and keep going.

Frequently Asked Questions

Q: How do I set a safe withdrawal plan when inflation hangs around 3% without blowing up my retirement?

A: Short answer: use guardrails, not autopilot. Start near 3.5%-4% of your portfolio, then adjust raises to inflation only when the portfolio is on track. I like a “guardrails” approach (think Guyton‑Klinger): give yourself a raise with CPI when the portfolio is healthy; cut the raise, or even trim spending 5%, after bad markets to avoid locking in losses. Keep 1-2 years of essential expenses in cash/T‑Bills, another 3-5 years in short/intermediate bonds (TIPS for essentials helps), and equities for growth. Rebalance annually and set a floor/ceiling (±20%) around your dollar withdrawals so you’re not guessing in the storm.

Q: What’s the difference between headline CPI and my personal inflation, and why does it matter for my budget?

A: Headline CPI is the national average basket; your basket is not average. This year CPI has hovered around ~3%, and the 2025 Social Security COLA is 3.2% (announced last year). But retirees often face higher healthcare, housing, and insurance costs, so your “personal CPI” can run hotter. Build your plan with category‑level inflators: use 3% for general spending, 5%-6% for healthcare, and whatever your property taxes/insurance have actually risen. That small tweak prevents underfunding the categories that bite.

Q: Is it better to build a CD ladder or stick with a 60/40 mix for retirement income right now?

A: They solve different problems. A CD/T‑Bill ladder is great for the first 3-5 years of known cash needs, very low volatility, but limited growth and poor inflation defense over decades. A 60/40 (or 50/50) adds growth to outpace 3% inflation but bounces around in the short run. A practical combo: 1-2 years cash-like, 3-5 years in high‑quality bonds/TIPS (a TIPS ladder for essential expenses is solid), and the rest in a diversified stock sleeve for long‑term growth. If you’re allergic to volatility, you can tilt 50/50 and accept a lower sustainable withdrawal rate (~3%-3.5%).

Q: Should I worry about sequence‑of‑returns risk if I’m mostly in broad index funds?

A: Yes, indexing doesn’t cancel the sequence problem. The risk is taking withdrawals after a downturn while your costs climb each year. Tactics that help: hold a cash/bond buffer so you’re not selling stocks in down years, cap your annual raise (e.g., CPI with a 0%-2% collar), pause discretionary withdrawals after a big drop, and rebalance methodically. Remember the Rule of 72: at ~3% inflation, prices double in ~24 years, so you need equity growth somewhere in the mix, just not forced selling at the worst times.

@article{retirement-budgeting-in-a-3-inflation-world,
    title   = {Retirement Budgeting in a 3% Inflation World},
    author  = {Beeri Sparks},
    year    = {2025},
    journal = {Bankpointe},
    url     = {https://bankpointe.com/articles/retirement-budgeting-3-inflation/}
}