Factoring in inflation in your retirement plan


Inflation is a priority for everyone today, perhaps especially retirees.

Inflation is important. But that’s just one of the risks retirees need to anticipate and manage. And like the other risks you need to manage, you can set up an income plan so that rising costs (real and feared) don’t ruin your retirement.

Inflation and your budget

Remember that in retirement your budget is different from where you worked, so you will be affected in different ways. And, of course, when you were working, your pay and bonuses could have increased with inflation, which helped offset cost increases in the long run.

A large part of your pre-retirement budget has been spent on housing – on average 30-40%. Retirees with smaller or repaid mortgages will have lower housing costs even if their children are busy taking out loans to buy homes, and even home equity loans to pay for home renovations.

On the other hand, while health care is a significant cost for everyone, for retirees it can grow faster than income. John Wasik recently wrote an article for The New York Times who cited a recent study showing that Medicare Part B premium increases alone will absorb much of the recent 5.9% increase in the cost of living in Social Security benefits. As Wasik wrote, “It’s hard to track the true cost of health care in retirement unless you plan ahead.”

Inflation and your sources of income

Protecting yourself in retirement means (A) creating an income plan that anticipates inflation over many years, and (B) allowing yourself to adjust to spikes in inflation that may affect your budget in the short term.

First, when creating your income plan, it is important to examine your sources of income to see how they react directly or indirectly to inflation.

  1. Some sources of income are quite resistant to inflation. Social security benefits, once elected, increase with the CPI. And some retirees are fortunate enough to have a pension that offers some protection against inflation.
  2. The dividends of stocks in high dividend portfolios have increased over time at rates that compare favorably to long-term inflation.
  3. Interest payments on fixed income securities, when invested for the long term, have a fixed rate of return. But there are also TIPS government-issued bonds that come with inflation protection.
  4. Life annuity payments are generally fixed, making them vulnerable to inflation. Although there are annuities available that can increase payments to fight inflation.
  5. Withdrawals from a rolling IRA account are variable and must meet RMD requirements, which do not keep up with inflation. The key to a retirement income plan, however, is that withdrawals can fill any inflation gap. In Go2Income planning, the IRA is invested in a balanced portfolio of growth stocks and fixed income securities. Although returns do fluctuate, the long term goal is to outperform inflation.
  6. Home equity withdrawals, which can be generated by various types of equity extraction vehicles, can be set by you as leveled or increasing amounts. The use of these resources should be limited as a percentage of the home equity.

The challenge is, with these multiple sources of income, how do you create a plan that protects you against the risk of inflation – as well as other retirement risks?

Key Risks a Retirement Income Plan Should Address

A good retirement income plan takes into account the many risks we face as we age. These include:

  1. Longevity risk. To help reduce the risk of outliving your savings, Social Security, retirement income, and annuity payments provide guaranteed income for life and become the foundation of your plan. For example, you need to be smart in your decision about when and how to claim your Social Security benefit in order to maximize it.
  2. Market risk. While the occasional “corrections” in the financial markets grab the headlines and are cause for concern, you can manage your income plan by reducing the dependence of your income on these returns. By having a significant percentage of your income safe and less dependent on current market returns, and replanning periodically, you are passing a significant portion of the risk (and reward) of the market on to your inheritance. In other words, children can receive an inheritance which in part reflects a downturn in the market, which can recover over the course of their lives.
  3. Risk of inflation. While a portion of each retiree’s income should be paid for life and less dependent on market returns, you should allow an explicit margin for inflation risk on your total income. The easiest way to do this is to accept lower income at the start. For example, under a Go2Income plan, our typical investor (a 70-year-old woman with $ 2 million in savings, 50% of which in a rolling IRA) might expect a starting income of $ 114,000 per year. year assuming 1% inflation. It would be reduced to $ 103,000 assuming 2%.

So what factors should you take into account in making that critical assumption about the level of inflation you need to factor into your plan?

Choose an assumed long-term inflation rate

Financial writers often talk about the magic of compound interest; in real terms, that translates to $ 1,000 growth of 3% per year for 30 years to reach $ 2,428. It sounds great when you are saving or investing. But what about when you spend? The purchase that costs $ 1,000 today could cost $ 2,428 in 30 years if inflation were 3% per year.

When designing your plan, what rate of inflation do you assume? Here are some possible options (hint: one option is better than the others):

  • Suppose the current inflation of 5.9% will continue indefinitely.
  • Suppose your investments will grow faster than inflation regardless of the level.
  • Assume a reasonable long-term inflation rate, just as you do your other assumptions.

We love the third choice, especially when you consider the table below. Despite today’s dramatically high rate of inflation affecting all graph results, the long-term rate of inflation over the past 30 years was 2.4%. Over the past 10 years, it was even lower at 2.1%.

A long-term view mitigates spikes in inflation

Manage inflation in real time

Whether you build your plan around 2.0%, 2.5%, or even 3.0%, it’s helpful to realize that not every short-term rate of inflation will match your plan’s assumption. My point is that there are a number of ways you can adjust to this short term inflation.

  • When possible, postpone purchases affected by temporary price increases.
  • When you can’t defer purchases, use your cash savings accounts to purchase the items and avoid dipping into your retirement savings.
  • If you think the price hikes are going to continue, revise your inflation assumption and create a new plan. Of course, regularly monitor your plan.

Inflation as part of the planning process

Go2Income planning attempts to simplify planning for inflation and all the risks associated with retirement:

  1. Make a long-term assumption as to how much inflation you’re comfortable with.
  2. Create a plan that lasts a lifetime by integrating annuity payments.
  3. Generate dividends and interest from your personal savings and avoid capital withdrawals.
  4. Use rolling IRA withdrawals from a balanced portfolio to meet your inflation-protected income goal.
  5. Manage your plan in real time and make adjustments to your plan as needed.

Inflation is a concern for everyone, whether you are retired or about to retire. Ptogether develop a plan to Go2Revenue then adjust it according to your expectations and your investments. We’re going help you create the best approaching inflation and any retirement risks you may face.

President, Golden Retirement Advisors Inc.

Jerry Golden is the Founder and CEO of Gold Retirement Advisors Inc. He specializes in helping consumers create retirement plans that provide income that cannot be survived. Learn more about Go2revenu.com, where consumers can explore all types of income annuity options, anonymously and at no cost.

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