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How To Manage The Risk Of Inflation In Retirement

Biphoo

11 Sep 2017

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How to manage the risk of inflation in retirement

Americans worry a lot about inflation. In fact, one in three (32%) Americans were either “panicked” or “very worried” about the rising cost of living in retirement, according to a recent study.

But that worry about what is also called purchasing power risk isn’t translating into action. It appears that 64%of Americans don’t have a financial plan that addresses the rising cost of living in retirement, according to the Allianz Life Insurance Company of North America. And the plan that most people have is this: Be more frugal with money.

So, what should Americans do to manage and mitigate the rising cost of living, which those surveyed by Allianz Life predict to rise 4.4% per year in retirement?

Get smart. Americans may not fully understand how inflation will affect them in their retirement. Consider: Respondents to the Allianz Life survey estimated by the average cost of living increase by 4.4% each year in retirement, but 31% of respondents thought the cost of living would go up between 5%-10% per year and nearly 1 in 10 (8%) reported costs would increase more than 10% each year. Inflation, however, has averaged 2.15% for the last 20 years, according to Allianz Life.

To be sure, there’s no guarantee that inflation will continue to average less than 3% for the next 20 years. But it’s a good idea to estimate inflation’s impact on your retirement plan by calculating what $1 today will buy in future years using best-, worst-, and likely-case estimates. To do this, use a calculator such as that found at Vertex42.com.

Also, learn how your expenses will change in retirement and the rate of inflation for those expenditures. “Take a comprehensive look at potential retirement-income expenses and consider the impact of inflation,” says Deb Repya, vice president of consumer insights for Allianz Life. “One key area of focus should be health-care costs and medical expenses. It is very likely that there will be greater expenses in these areas the older one gets, particularly once retirement age is reached."

Health care costs, for instance, represent 8.8% of all expenditures for Americans ages 55-64 but rise to 15.6% for those ages 75 and older. Consider also reading reports posted by Labor Department’s Bureau of Labor Statistics, such as a closer look at spending patterns of older Americans, to get a realistic idea expenses in retirement. Of note, people tend to gradually slow down in retirement — and slow down their spending — as they grow older. That too should be factored into your strategy to deal with inflation in retirement, says David Laster, a New York-based retirement strategist.

To deal with future health care costs, consider buying long-term care insurance while in your 50s or 60s, especially if there is no family member available to provide this care if needed. Some 70% of Americans ultimately need such care, says Laster.

Also, shop health-care plans every year during retirement. “Most plans have a maximum out-of-pocket cost so you know in a worst-case scenario what your expense would be,” says Dana Anspach, founder and CEO Sensible Money.

Estimate the number of potential years of retirement. The longer you live, the more you need to worry about the loss of purchasing power. You can estimate your life expectancy, how many years of retirement you might have to fund, by using online calculators such as the Living to 100 Life Expectancy Calculator.

“With better health care and longer life expectancies, someone retiring today at age 65 can expect to live another 20 years based on life expectancy tables. Even with a modest inflation rate of 2.5%, costs would double over the course of a period of 28 years,” says Repya. “Also, if married, consider the possibility that one partner may live much longer into retirement.”

Don’t forget to assess your current health status when thinking about potential life expectancy, says Repya.

Review retirement income sources and assess if they can help address inflation. “Determine whether cost-of-living adjustments or potential increases apply to sources of income,” says Repya. “While Social Security might effectively address inflation, some investments or other financial vehicles might not. Also, consider the impact of potential low interest rates and rising inflation rates during retirement as total rates of return could be much different than anticipated.”

Don't wait, develop a plan to address inflation now. Ideally, says Repya, you would work with a financial professional to see what strategies and products should be considered to help address the risk of inflation during retirement.

“There are multiple variables to take into account, and without proper guidance there are many potentially damaging assumptions that can be made,” she says. “For example, while Social Security adjusts to an extent for inflation, it very well might not keep pace with health-care expenses. The average annual cost-of-living increase for Social Security over the past 30 years has been 2.6%. Meanwhile, the average annual premium increase for Medicare Part B over the same 30-year period has been 6.2%.”

Laster also says working with a financial adviser is helpful. “Retirees should consult an adviser to confirm that they are spending at a sustainable rate,” he says. “For those over 70, spending annually at a rate one-percentage point above the Internal Revenue Service’s required minimum distribution (RMD) rate is a reasonable rule-of-thumb.” The RMD rate is the amount one must withdraw from their retirement accounts after turning 70½.

Delay Social Security. One of the best things you can do to mitigate the risk of inflation is delay the start date of your Social Security, says Anspach. “Your Social Security benefit amount automatically goes up with inflation. You get a larger amount of Social Security by starting benefits at a later age. The annual increase tied to inflation will now apply to that larger amount.”

Laster agrees with this advice. “Another way to mitigate inflation risk is to delay claiming Social Security until 70 if you are in reasonably good health,” he says. “This maximizes the level of a government-provided monthly benefit that rises with inflation.”

Personalize your inflation risk. Inflation affects sectors of the population differently, says Anspach. “If you are living on less than $50,000 a year in retirement increases in necessities such as energy, health care, and food will affect you,” she says. “By working longer and delaying the start date of Social Security, you will be better prepared to handle these increases.”

If, however, you are a higher income, higher net worth household, inflation is less likely to have a big negative impact on your plan, says Anspach. “As you age, you will naturally spend less on entertainment, travel, and other ‘extras’ and will easily be able to absorb price increases on basics without feeling like you are constrained,” she says.

Save and invest. One way pre-retirees can manage the ravages of inflation in retirement is to make sure they have enough money set aside in their nest egg before retiring. “Preretirees should save automatically and consistently, aiming for at least 10% of earnings including employer match, if any,” says Laster. “Retirees should also view themselves as long-term investors and, as such, maintain a meaningful allocation — at least 40% — to stocks.”

Biphoo

11 Sep 2017

297 Views

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How to manage the risk of inflation in retirement

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