Managing Inflation in Retirement


Inflation has seemed tame or even non-existent in recent years. The threat of inflation, along with the potential for the Federal Reserve to raise interest rates to combat it, has contributed to volatility in the stock market from time-to-time. Consumer prices rose 2.1 percent  for the twelve months ending November 2019.

An annual inflation rate of 2 or 3 percent over a period of years can seriously erode the purchasing power of your retirement nest egg. At 2.5 percent inflation, $1 today will be worth approximately 78 cents in 10 years, 61 cents in 20 years, and 48 cents in 30 years. This could have a major impact on those entering retirement and those in retirement.

Managing inflation in retirement is crucial, here are some thoughts you need to consider.

Manage all of your retirement resources

Most people have multiple sources of retirement income which might include:

It is important to identify all of these financial resources and to manage them in a fashion to maximize their benefit to your retirement.

Use a conservative inflation rate for planning purposes

Since your retirement is likely to span decades, consider inflation over long time periods. Inflation is running at historically low levels, this won’t last forever. However since World War II inflation has averaged well over 3 percent. Inflation will have a huge impact on your retirement finances, assuming today’s low inflation rate into retirement could be setting you up for disappointment down the road. 

Invest to stay ahead of inflation

Your investments should be diversified among various asset classes based upon your risk tolerance, your income needs, your age, etc.  That said don’t be too conservative. While it might be tempting to shy away from risk in retirement, especially given the financial crisis of 2008-2009, for retirees their greatest retirement risk is outliving their money. Being too conservative can easily lead to this. For most investors, a portion of their portfolio should remain invested in stocks, which have typically earned returns in excess of inflation over time.

Make good pension decisions

If you are covered by a pension plan you likely have options as to whether you want to take your benefit as a series of monthly payments over your lifetime or as a lump-sum payment. Either option can be the right choice depending upon your situation. Most corporate pension plans do not offer cost of living increases so your monthly payments will lose value over time in real terms due to inflation. On the other hand, most public and municipal pensions do have cost  of living adjustments, though there is no guarantee that future increases will keep pace with actual rate of inflation.

Taking a lump-sum distribution and rolling it over to an IRA assumes that you are comfortable managing and investing this money on your own or that you have a relationship with a financial advisor to help you do it. A properly invested portfolio has the potential to earn enough to keep you ahead of inflation. On the flip side, it’s important to remember that investments can lose money as well.

Make sound Social Security decisions

You are eligible to begin collecting Social Security benefits at age 62. If you opt to take benefits that early your monthly payment will be permanently reduced. If you wait until your full retirement age, age 66 for those born prior to 1960, your monthly benefit will be higher. If you are able to wait until age 70 your monthly payment amount will increase 8 percent for each year that you wait after reaching your full retirement age.

The increases are also prorated, so if you were to commence benefits at say age 65 your benefit would be proportionally higher than at age 62. Waiting longer also increases the size of your cost of living increases as these will be based upon the higher starting benefit amount.

Reduce your fixed expenses 

For many entering retirement their biggest fixed expense might be their mortgage. If your mortgage payment is affordable, if you have a large nest egg and perhaps will be receiving a pension then perhaps having a mortgage in retirement will not pose a financial hardship. At the very least make sure that your housing costs are affordable. If they are not maybe this is the time to downsize.

Prior to retirement is a good time to look at your monthly expenses. Where can you cut back without reducing your quality of life? Do you still need all of those cable channels your kids used to watch when they lived at home? Can you adjust your cell phone plan? Do you need that second car? The point is that the leaner your monthly expenses are entering retirement the better able you will be able to cope with the impact of inflation or other unplanned expenses that can arise.

Plan for healthcare costs

Health-care costs have tended to increase faster than overall rate of inflation. It is crucial that retirees factor in the cost of healthcare into their retirement budget. While Medicare will help once you turn age 65, it still does not cover everything. In their latest survey, Fidelity pegs the cost of healthcare in retirement at $275,000 for a couple both aged 65, an increase of almost 5.8% from their 2016 survey.

It is incumbent upon pre-retirees to save enough to cover their healthcare in retirement. If your health insurance plan is a high-deductible plan with access to an HSA I urge you to take advantage of this opportunity. Salt away as much as you are allowed and if possible cover your deductibles and out-of-pocket costs from other sources while you are working. Let the HSA grow and then use these funds to cover Medicare supplement insurance and other healthcare costs in retirement.

Plan for your long-term care needs 

Very much related to the cost of healthcare in retirement is the cost of long-term care if needed. Costs will vary based upon where you live, whether you are in a facility or receive care at home and a multitude of other factors. Long-term care insurance is one way to offset some or all of these potential costs.  LTC insurance can be quite expensive and only gets more expensive the older you get. Insurance is often cited as most appropriate for those in the middle in terms of net worth. The poor can often rely on Medicaid and the rich can usually self-fund this expense.

The right answer will depend upon what you can afford in terms of premiums and how much of your savings you are willing to spend on this cost. The bottom line here is that you need to assume you will need long-term care at some point and have a plan to fund these costs. No surprise, these costs are increasing and will be a contributing factor to retirement inflation in the future.

Invest in tax-advantaged investment vehicles while you are working 

Utilize your employer’s 401(k) plan or similar plans such as a 403(b) or 457. Contribute to an IRA. If you are self-employed start and fund a self-employed retirement plan such as a Solo 401(k), a SEP-IRA or other plan. Since you aren’t paying income taxes on earnings throughout the years, that typically means you’ll have a larger balance at retirement than if you were paying taxes on these investment gains throughout the years. You’ll start out with a larger retirement base to help combat inflation’s effects.  If some of this money is in a Roth IRA or Roth 401(k) withdrawals are tax-free to boot.

Minimize withdrawals especially during the early years of retirement

To counter inflation, you will need to withdraw larger and larger sums just to maintain the same purchasing power.To make sure you don’t run out of funds late in life, keep withdrawals during the early years to a minimum. Conventional wisdom in the financial planning world says that 3-4 percent can generally be withdrawn each year.

The reality is this is at best only a rule of thumb. The amount you spend in retirement will likely not be linear and will evolve over the course of your retirement. For example travel and other aspects of an active lifestyle might be more prevalent early in your retirement. Depending upon your health, the cost of medical care might increase during the later years of retirement. Minimizing your withdrawals from retirement accounts during the early years of retirement can help ensure that the funds you need will be there later on in retirement.

Work in retirement 

For some the best way to make sure they are protected from inflation is to work a bit longer or to work at least part-time for a few years into retirement. This will add to your spendable cash flow and lower the amount you need to take from savings for a few years; both can help you combat inflation during retirement. 

Be prepared for change

Things will change during the course of your retirement. You need to manage the financial aspects of your retirement.  Watch your withdrawals, manage your investment allocation and monitor your spending. Be prepared for the unexpected including changes in your health.

The Bottom Line 

Inflation is the worst enemy of retirees, it should be feared at least as much as any potential for investment loss. Not preparing for inflation in retirement can cause you to run out of money at a time of life when this situation is hard to rectify. The fact that many retirees are on fixed incomes either in total or in part makes them susceptible to the ravages of inflation. Managing the impact of inflation in retirement should be a top priority for all retirees.

Managing your investments and spending to minimize the impact of inflation will go a long ways toward ensuring a financially successful retirement, as will saving and investing as much as you can during your working years.

Approaching retirement and want another opinion on where you stand? Need help getting on track? Do you have the right mix of investments to stay ahead of inflation? Check out my Financial Review/Second Opinion for Individuals service for detailed advice about your situation.

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