Personal Finance

Inflation Retirement How Protect

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 9 minute read

Inflation can be like aging or gaining weight in that it often occurs without the victim realizing it is happening. But it might have a major effect on your retirement savings over time.

To illustrate, say you anticipate retiring in 30 years. You estimate that you’ll need $1.5 million in retirement savings to enjoy a comfortable lifestyle for 25 years, so you save diligently throughout your working life to ensure that you have enough saved by the time you stop working.

But if inflation averages 3% every year, your cost of living will more than quadruple in that time period. The $1.5 million you have saved by the time you retire will only last you a little over eight years. As time passes, its value as a purchasing tool will decrease further.

How to Avoid Inflation While Retiring

Inflation must be included in any solution to this issue. Think about it while determining when you want to retire and how much money you need to save. The next step is to pick investments that will yield a return that is at least as high as inflation.

1. Maintain Your Investment Plan

The single most important thing you can do to ensure you have enough money in retirement to live comfortably above inflation is to save and invest regularly while you are still working. 

A greater return, relative to inflation, can be expected from investments held over long periods of time.

When saving for retirement, it’s smart to put money into a tax-deferred retirement plan like a 401(k) or a standard or Roth individual retirement account (IRA). Money invested in a traditional IRA is exempt from taxes now, while money invested in a Roth IRA is exempt from taxes after retirement.

The investments in your retirement portfolio should be diverse. It’s best to prioritize high-risk, high-reward investments if you’re decades away from retiring. Mutual funds, ETFs, and real estate are some good investment choices.

A financial counselor or Robo-advisor can help you decide which investments are best for your retirement portfolio.

2. Prioritize Safer Investments as Retirement Nears

It’s important to use a slightly different strategy to hedge against inflation as retirement approaches. Because you need the money from your assets to sustain yourself, you can’t afford to take any unnecessary risks with them in the short term.

Investing in safe, high-yielding options is a must right now. Certificates of deposit (CDs), Treasury bonds, municipal bonds, and annuities are some good low-risk investments to have as retirement approaches.

Even while your initial investment is safe, you run the danger of the interest rate not keeping up with inflation. When inflation is high, it diminishes the purchasing power of cash that is locked up at a low fixed interest rate.

A good way to hedge against this possibility is to maintain some of your retirement money in more volatile assets like equities. Pay special attention to the stock prices of energy, healthcare, and consumer staples companies. 

Businesses in these industries fare well during periods of high inflation because they are able to raise prices without losing clients.

To protect your nest egg, you should put more money into safe assets as retirement approaches. Investing in a target-date fund allows your portfolio to adapt to your evolving risk tolerance without your involvement.

3. Invest in Inflation Hedge Instruments

Investments with built-in inflation protection are another option for limiting the damage that inflation can do to your retirement fund. 

Potential examples include:

  • TIPS. Fixed-interest Treasury Inflation Protected Securities (TIPS) are issued by the United States Treasury. However, their purchasing power fluctuates with the rate of inflation. Interest is compounded semiannually and is calculated using the purchasing power as adjusted for inflation.
  • I-Bonds. Series I savings bonds, also known as I bonds, offer a low fixed interest rate in addition to a variable interest rate according to the rate of inflation. You will receive the face amount of the bond plus interest accrued when you redeem it.
  • Annuities. When it comes to inflation, some annuities are better than others. In most cases, the return on investment provided by fixed-indexed annuities exceeds the rate of inflation. In addition, the rate of return on inflation-adjusted annuities is guaranteed to be more than the rate of inflation.
  • Bank Notes With a Variable Interest Rate. They are bonds having an interest rate that fluctuates based on a predetermined index, usually the federal funds rate. These bonds are relatively inflation-proof since the Federal Reserve typically boosts interest rates in response to rising inflation.

Investments that traditionally perform well in times of high inflation are another type of inflation hedge. REITs, precious metals, and commodities are all types of investments.

There are others that buy cryptocurrencies to protect their wealth from inflation. Crypto doesn’t do this function particularly effectively, according to a 2022 report by Bank of America (reported by Yahoo). The investment is extremely risky for those getting close to retirement age because of its high volatility.

4. Reduce Debt

If you want to make sure your retirement savings will last throughout your golden years, cutting back on monthly spending is a good place to start. When they are low, living on a fixed income is less of a struggle. Paying down debt is a significant expense reduction strategy.

Having to pay off debt might be like dragging an anchor around on your spending plan. You have to keep shelling out cash every month to pay off your credit card bills, your student loans, and your mortgage, and you’re not getting any value in return. Resolving this debt will free up funds for other uses.

Debt with a fluctuating interest rate, like that from an adjustable-rate mortgage, is a particularly pressing example to eliminate (ARM). Interest rates, which typically increase in tandem with inflation, also increase these payments. Pay off your adjustable-rate mortgage (ARM) as soon as feasible before retiring.

5. Reduce Your Expenses for Living

Repaying debt is a substantial outlay, but it’s far from the only one. You can bring your monthly living expenses down to a more bearable level by cutting out some of your other major outlays, such as:

  • Housing. If you’re looking to cut back on housing costs, you might want to consider moving into a smaller home, downsizing to an apartment, or refinancing your mortgage. The property tax and other housing costs should be taken into consideration while choosing a retirement location.
  • Transportation. It’s recommended that car owners delay purchasing a replacement vehicle for as long as feasible. DIY auto repairs are another good way to cut costs. Reduce your driving when petrol prices are high by sharing rides or taking public transit more often. Think about whether you need two cars, or if you could do without one totally.
  • Food. The best method to save money on food is to cook at home rather than eat out. Buying store brands, shopping at a discount supermarket, and cutting down on meat consumption are all great ways to reduce your weekly food bill.
  • The Minding of Children. Look around for the best deal if you need to put your kids in daycare. Think about the possibility of working from home, or of having both parents work different hours so that one is always home so that you can eliminate the need for daycare altogether.

Getting ahead financially before retirement is beneficial in more ways than one. To start, it’s an additional dollar that can be placed toward your retirement fund. Second, it lessens the sum you’ll have to put away in savings. The smaller your monthly expenditures, the less money you’ll need to live comfortably in retirement.

6. Postpone Retirement

Putting off retirement for longer is another method to eat into your savings. If you can reduce the number of years you plan to spend in retirement, you can spend less overall.

A part-time retirement is an option for those who are unable or unable to continue working full-time in their 60s and 70s. The ability to work fewer hours while still bringing in some money and having more free time is a major benefit of cutting back to a part-time schedule.

You could, on the other hand, leave your current position and look for temporary work in an unrelated field. Taking on new challenges, including learning new work skills, can help you maintain cognitive function as you age.

7. Postpone Social Security Benefits

Putting off retirement does more than just give you extra time to enjoy your money. Maximizing your Social Security benefits is another way it might boost your retirement income. The reason for this is that when you begin receiving Social Security benefits can significantly affect the total amount you get.

The earliest eligibility age for receiving benefits is 62. However, if you do this, you would receive a smaller monthly payment than if you waited until your full retirement age, which is 66 or 67 years old, depending on when you were born. You can maximize your payout by waiting to start receiving benefits until you turn 70.

The savings from postponing benefits are income-dependent. Social Security Administration projections for 2022 indicate that the maximum monthly payment for a person retiring at age 62 is $2,364, for those retiring at age 67 it is $3,568 and for those retiring at age 70 it is $4,194.

8. Increase Other Income Streams

In order to make your retirement savings last longer, it is a good idea to set up supplementary income sources. Starting a side business at this time is one option. With any luck, by the time you’re ready to hang up your work boots, your company will be bringing in a healthy profit.

Rental properties, a blog, or royalties from a book are all good examples of passive income sources. The initial work required to create passive income is usually substantial. But if you do the hard work now, you can enjoy the fruits of your labor well into your golden years.

9. Prepare a Budget for Medical Expenses

Healthcare expenditures pose a significant problem for seniors. According to research conducted by Fidelity in 2022, retirees typically spend 15 percent of their income on healthcare. This includes both Medicare-related costs and out-of-pocket costs.

One way to save up for medical costs in advance is via a health savings account (HSA). In conjunction with a high-deductible health insurance plan, this savings vehicle allows you to put away money before taxes. Tax-free withdrawals from this account can be made at any time to cover future medical costs.

Consideration of the financial burden of long-term care is also crucial. More than half of all U.S. citizens over the age of 65 will require long-term care services over their lifetimes. It’s not covered by most medical insurance plans and can cost several thousand dollars every month.

Insurance against the high expense of long-term care is one option. It’s ideal to purchase a policy in your early 50s. If you put off getting insurance, your monthly payments will increase.

Long-term care expenses can also be covered by specialized annuities. Until you receive a diagnosis of an illness that necessitates long-term care, your long-term care annuity will not begin to pay out. This type of annuity may have less stringent eligibility requirements than traditional LTC coverage.

10. The Long Term

When saving for retirement, it’s crucial to account for inflation. Inflation of just 3% per year during a 25-year retirement period might slash your savings by more than half. And if inflation hits 8%, your savings might lose over 85% of their value.

A financial planner worth their salt will have retirement planning software that automatically adjusts for inflation. If not, you can find retirement savings calculators online that factor in inflation.

However, these tools often assume a low rate of inflation, between 2% and 3%. However, in June of 2022, the annual inflation rate in the United States was 8.6%. If inflation remains at its current rate of 3 percent per year, your retirement savings plan could easily be in jeopardy.

Recalculating everything is a good idea just to be sure. This time, let’s say you plan on retiring in 20 years and inflation averages 4% or 5% every year. The updated computation will reveal the size of the nest egg required in this scenario and the extent to which retirement savings need to be increased.

Bottom Line

In order to ensure a comfortable retirement, you need to continue working on your retirement plan even after you stop working. Having a plan for your retirement funds is essential.

The first rule of saving is to determine a safe withdrawal rate that will ensure your funds will last as long as you do. An old rule of thumb recommended spending no more than 4% of your retirement fund annually. 

While bond rates have decreased as a result of higher life expectancies, the opposite is true now. So, many financial experts say a 3.5% withdrawal rate is more prudent.

It is also crucial to limit spending. Your annual savings rate of 3.5% will be sufficient for living expenses if they are low enough. And if you find you still need a little extra cash, there is plenty of part-time employment that won’t interfere with your ability to enjoy your retirement.

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