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How to Beat Inflation in Retirement

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Like aging or weight gain, inflation can creep up on you so gradually you don’t even notice it. But over time, it can have a huge impact on your retirement portfolio.

For example, suppose you want to retire in 30 years. You calculate that a nest egg of $1.5 million should see you through 25 years of retirement, and you plan your retirement contributions at every age to hit this target on your retirement date. 

But if inflation is a steady 3% per year, your living expenses will more than double over those 30 years. By the time you retire, your $1.5 million will only be enough to support you for a little over eight years. And its purchasing power will continue to erode over time.

How to Beat Inflation in Retirement

To avoid this problem, you need to factor inflation into your financial planning process. Keep it in mind as you set your financial goals, and adjust your retirement age and income as necessary. Then choose investments that will earn enough to keep pace with inflation and then some.

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1. Stick to Your Investment Strategy

The most important rule for beating inflation in retirement is to save and invest steadily throughout your working years. The longer you keep your money invested, the better your chances of earning a return that outpaces inflation.

The best place to invest for retirement is a tax-advantaged retirement plan such as a 401(k) or a traditional or Roth IRA. Traditional IRAs let you invest tax-free dollars now, while Roth IRAs let you avoid taxes in retirement.

Your retirement portfolio should include a mix of investments. If you’re decades out from retirement, focus more on higher-risk, higher-return investments. Good options include stock and bond mutual funds, exchange-traded funds (ETFs), and real estate. 

If you’re not sure what investments to include in your retirement plan, talk to a financial advisor or try a robo-advisor.

2. Focus on Safer Investments as You Near Retirement

When you’re nearing retirement, you need a somewhat different approach to protect yourself from inflation. You can’t afford to take as much short-term risk with your investments because you need them to provide a steady income for you to live on.

In this situation, you need investments that offer decent yields with little risk. Good lower-risk investments as you near retirement include certificates of deposit (CDs), Treasury bonds, municipal bonds, and annuities.

These investments protect your principal, but they carry a risk of their own: the interest rate they pay might not keep pace with inflation. If the inflation rate is high, money tied up at a low, fixed interest rate will lose value over time.

To protect yourself from this risk, keep a portion of your retirement savings in higher-risk investments, such as stocks. In particular, consider stocks of energy, health care, and consumer staples businesses. Companies in these sectors tend to do well when inflation is high because they can raise their prices without losing customers.

The closer you get to retirement age, the more your retirement fund should shift toward low-risk investments. A target-date fund can automatically adjust your portfolio to fit your changing risk tolerance over time.

3. Invest in Inflation Hedges

Another way to reduce inflation’s impact on your retirement savings is to choose investments that have inflation protection built in. Some possibilities include:

  • TIPS. Treasury inflation-protected securities (TIPS) are a type of government bond that pays a fixed interest rate. However, their actual face value rises and falls to match inflation. The twice-yearly interest payments are based on the inflation-adjusted value.
  • I-Bonds. Series I savings bonds, or I bonds, pay a low, fixed interest rate, plus a variable rate that’s linked to the inflation rate. When you cash them in, you get the full value of the bond plus the accumulated value of all the interest it’s earned.
  • Annuities. Some types of annuities provide inflation protection. Fixed-indexed annuities deliver a return tied to a stock market index, which usually outpaces inflation. And inflation-adjusted annuities have a built-in cost-of-living adjustment, so their rate of return always beats inflation. 
  • Floating-Rate Notes. These are bonds with a variable interest rate that’s tied to a benchmark such as the federal funds rate. Since the Federal Reserve generally raises interest rates when inflation rises, these bonds tend to hold their value against inflation.

Other inflation hedges are simply investments that tend to do well during periods of high inflation. Examples include real estate investment trusts (REITs), precious metals, and commodities.

Some investors also treat cryptocurrency as an inflation hedge. However, a 2022 report by Bank of America (published by Yahoo) shows that crypto doesn’t do this job very well. It’s also a highly volatile investment, which makes it very risky for anyone nearing retirement.

4. Pay Down Debt

One of the best ways to ensure your retirement savings can see you through your retirement years is to reduce your monthly expenses. The lower they are, the easier it is to get by on a fixed income. And one important way to reduce your expenses is to pay off debt.

Debt is like an anchor weighing down your budget. The monthly payments on credit card debt, student loans, and even your mortgage cost you money month after month without giving you anything in return. Paying them off frees up extra cash for living expenses.

One particularly important type to get rid of is variable-rate debt, such as the payments on an adjustable-rate mortgage (ARM). These payments rise along with interest rates, which generally rise when inflation does. If you have an ARM, pay it off before you retire if at all possible.

5. Lower Your Cost of Living

Debt payments are only one of many big expenses in your budget. To get your cost of living down to a manageable size, look for ways to cut your other big expenses, such as:

Each dollar you can cut from your budget before reaching retirement helps you twice. First, it’s one extra dollar you can put toward your retirement savings. Second, it reduces the amount you need to save. The lower your expenses are, the less you need to last you through retirement.

6. Delay Retirement

Another way to reduce your retirement nest egg is to wait longer to retire. The fewer years of retirement you need to pay for, the less money you need to get you your time as a retiree.

If you’re not able or willing to keep working full-time in your 60s and 70s, you can compromise by retiring partially. Going down to a part-time work schedule allows you to keep bringing in some income while still increasing your leisure time.

Alternatively, you could quit your job and find part-time work in a brand-new field. Learning the skills needed for a new job can help you keep your mind sharp as you age.

7. Delay Social Security Benefits

Waiting to retire does more than just stretch your existing savings. It can also increase your retirement income by helping you maximize your Social Security benefits. That’s because the amount you get from Social Security depends on when you start collecting it.

You can begin collecting benefits as early as age 62. However, if you do this, you’ll get less each month than if you wait until your full retirement age, which ranges from from 66 to 67 depending on when you were born. And if you delay taking benefits until age 70, you get the maximum amount.

The amount you gain by delaying your benefits depends on your earnings. According to the Social Security Administration, the maximum possible benefit amount for a worker retiring in 2022 is $2,364 per month at age 62, $3,568 at age 67, and $4,194 at age 70.

You can stretch your retirement savings by creating extra income streams to help support you in retirement. One way to do this is to start a side business now. By the time you retire, your business could be a significant source of income for you.

You can also look for sources of passive income, such as rental properties, a blog, or royalties from published works. Creating passive income often involves some hard work up front. But by doing the heavy lifting now, you can reap the benefits throughout your retirement years.

9. Make a Plan for Health Care Costs

One of the biggest challenges for retirees is health care costs. A 2022 study by Fidelity found that the average retiree spends about 15% of their retirement income on health costs. That includes Medicare premiums and expenses Medicare doesn’t cover.

A health savings account (HSA) can help you plan ahead for these expenses. It’s a type of savings account you pair with a high-deductible health plan and fund with pretax dollars. You can use these funds for health expenses at any time throughout your life, tax-free.

It’s also important to plan for the costs of long-term care. A majority of Americans over 65 will need long-term care at some point. It can cost thousands of dollars per month, and most health insurance plans don’t cover it.

One way to handle this cost is to invest in long-term care insurance. The best time to buy a policy is when you’re in your early 50s. The longer you wait, the higher your premiums will be. 

There are also annuities designed specifically to cover long-term care costs. A long-term care annuity doesn’t pay out until you’re diagnosed with a condition that requires long-term care. These annuities can be easier to qualify for than a long-term care policy.

10. Think Long Term

It’s important to factor in inflation as you plan for retirement. An inflation rate of just 3% can cut the value of your retirement fund by more than half over a 25-year retirement period. And if inflation rises as high as 8%, it can eat away more than 85% of the buying power of your savings.

If you work with a financial planner, they should have software that accounts for inflation in calculating your retirement needs. If not, there are retirement savings calculators available online that account for the cost of inflation. 

However, these calculators are often set to assume a modest inflation rate of around 2% or 3%. But as of June 2022, the annual inflation rate in the U.S. stood at 8.6%. If you calculated your retirement savings needs based on annual inflation of 3%, you could easily fall short if inflation stays this high.

To be on the safe side, run the numbers again. This time, assume that yearly inflation will average 4% or 5% between now and the time you retire. The new calculation will show you how big a nest egg you’ll need in this situation, and how much you need to step up your retirement savings to accumulate it.

Final Word

The process of planning a sustainable retirement doesn’t end on the day you retire. Managing your money during retirement is important too.

The most basic rule is to choose a safe withdrawal rate for your savings so they’ll last as long as you need them. In the past, a common rule of thumb was to withdraw 4% of your retirement savings each year. But today, lifespans are longer, while bond yields are lower. Thus, many financial advisors argue that a 3.5% withdrawal rate is more reasonable.

Keeping expenses under control is also important. The less you need to live on, the less you need to save to live on that 3.5% per year. And if you need additional income, there are many side jobs that can provide it while still leaving you plenty of time to enjoy your golden years.

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