Managing Inflation in Retirement

Roger Wohlner, The Chicago Financial Planner

By Roger Wohlner,

Special to the Financial Independence Hub 

Inflation may seem like a tame or even non-existent threat. We are actually witnessing deflation in the price of oil and other commodities as I write this. Even so, it’s highly unlikely that inflation is dead. The U.S. economy continues to recover from the financial crisis and times of economic recovery are often a trigger for higher inflation.

An annual inflation rate of 2 per cent or 3 per cent over a period of years can seriously erode the purchasing power of your retirement nest egg.  At 2.5 per cent inflation, US$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 already 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 that 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. Currently inflation is running at historically low levels, under 1 per cent by some measures.  However since World War II inflation has averaged well over 3 per cent.  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, I always caution retirees that their greatest risk is outliving their money.  Being too conservative can easily lead to this.  Likely, a portion of your 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 an annuitized 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 the 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 adviser 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, generally 66 for most people, your monthly benefit will be 33 percent higher. If you are able to wait until age 70 your monthly payment amount will be another 35 per cent higher.

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 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 the overall rate of inflation. It is crucial that retirees factor in the cost of healthcare into their retirement budgets. While Medicare will help once you turn age 65, it still does not cover everything. The cost of healthcare in retirement is often cited as an item that becomes the budget-buster for many retirees.  Look into supplemental policies and prescription coverage to help with those non-covered expenditures, especially if your employer does not provide health insurance after retirement.

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 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 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 source of retirement inflation if you need this type of care.

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 throughout the years. Thus, 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% 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 into retirement as specific costs increase and to combat the general impact of inflation.

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 your 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 far more than 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 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.

Roger Wohlner is an experienced financial advisor based in Arlington Heights, Ill. He is active on social media; you can follow him on Twitter and Google+. Roger contributes to his own popular finance blog, The Chicago Financial Planner, where he writes about issues concerning financial planning, investments and retirement plans. In addition his work has been featured on Investopedia, US News & World Report, Yahoo! Finance, Equifax Finance Blog and other publications. Roger is available for additional freelance financial writing assignments. The above piece, Managing Inflation in Retirement, originally appeared on his blog, and is republished here with the author’s permission. 


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