Managing inflation risk in retirement 

Inflation’s impact on retirement income

If you purchase a loaf of bread in five years, it’s likely to cost more than it does today. This ongoing increase in the cost of living is known as inflation, and it affects just about everything we buy. Inflation can be especially troubling during retirement. Other than the annual cost-of-living adjustment to Social Security benefits, a retiree’s income often remains constant while prices continue to rise. Investments may not keep up with inflation either as retirees tend to become more conservative with their investment strategies. Although inflation poses a challenge to future purchasing power, you can reduce its effects during retirement by putting certain strategies in place now.

Retirement planning inflation strategies

Taking inflation into account is crucial to successful retirement planning. In addition to saving for retirement, it’s also necessary to protect those savings from inflation by taking steps to reduce taxes and optimize growth.

Maximize tax-advantaged accounts

Consistently contributing to tax-advantaged accounts like 401(k)s and IRAs is a great way to maximize your savings. You won’t lose a portion of your principal to taxes each year, and you may be able to invest more than you would have otherwise since you can deduct the contributions. In addition to the built-in tax advantages of 401(k)s, some employers provide added benefits by matching your contributions up to a certain amount. IRAs offer similar tax advantages to 401(k)s, but aren’t employer-sponsored. Depending on whether you have a traditional IRA (funded with pre-tax dollars) or a Roth IRA (funded with after-tax dollars), your tax advantages will differ. Consulting a tax professional is recommended to make sure you choose the best account or combination of accounts to optimize your tax strategy and comply with all the necessary tax laws.

Diversify your investments

When it comes to investments, diversification is always a smart strategy, and it can help fight inflation. For the most part, markets typically outperform inflation over the long term. Individual stocks or commodities are far more volatile. If your portfolio holds only a few different assets or stocks, it can rise and fall more dramatically with every small market movement. Having a wide base and a diversified portfolio will help shield your savings from high volatility. Particularly when you are approaching retirement age, you may want to switch your focus from growth to a more conservative strategy.

Invest in inflation-protected assets

Some assets increase in value during times of inflation. Investing in them can provide a buffer against the effects of inflation.

• Real estate is an appreciating asset that may also provide rental income. Real estate investment trusts (REITs) also tend to perform well against inflation, as rents and property values tend to go up along with prices.
• During times of high inflation, many investors turn to tangible assets, including commodities like gold, oil, and natural gas, as well as agricultural products like grain and coffee.
• Treasury Inflation-Protected Securities (TIPS) are a type of Treasury bond issued by the U.S. government. The principal value of these bonds is adjusted to keep pace with inflation, ensuring that their value remains stable.
• Savings bonds tend to perform well in times of inflation and are often used to balance investments in equities like stock.

Consider annuities

Inflation-protected annuities guarantee a rate of return at or above the inflation rate. Fees and caps on payments may apply, so it’s important to understand the terms that accompany an annuity to avoid surprises.

Do pensions increase with inflation?

Social Security and many government pensions are adjusted each year for inflation through cost-of-living adjustments. Most private pension plans do not adjust for inflation, and those that do may not increase at a rate that covers inflation.

Planning for inflation as a near-retiree

The closer you get to retirement, the more often you’ll want to review your plans and assess how they’ll fare against inflation. Here are a few additional considerations:

Keep an emergency fund

Maintaining an emergency fund is important both before and during retirement. Having cash reserves can help ease the pressure of inflation. The cash value of universal life or whole life insurance policies can also provide access to funds should the need arise.

Maintain spending flexibility

A general rule of thumb for retirees is that you can spend up to 4% of your savings each year. This 4% rule is a general guide to ensure that your savings last throughout retirement. In times of high inflation, it may be wise to adjust your budget and spending to accommodate higher costs while still meeting your essential needs.

Seeking professional financial advice

The financial strategies listed above can help you ensure that your retirement savings maintain their value, even as inflation rises. However, there are several intricacies to consider—such as current tax laws and the terms and conditions that accompany specific accounts. Consulting a trained financial professional can help you optimize your retirement planning and reduce the effects of inflation.

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