Factoring Inflation Into Your Retirement Plan

Contributed by: Jonathan Thomas, Private Wealth Advisor, LVW Advisors 

Inflation and Your Sources of Income

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

First, when creating your income plan, it’s important to look at your sources of income to see how they respond directly or indirectly to inflation.

1. Some income sources weather inflation quite well. Social Security benefits, once elected, increase with the CPI. And some retirees are fortunate enough to have a pension that provides some inflation protection.
2. Dividends from stocks in high-dividend portfolios have grown over time at rates that compare favorably with long-term inflation.
3. Interest payments from fixed-income securities, when invested long-term, have a fixed rate of return. But there are also TIPS bonds issued by the government that come with inflation protection.
4. Annuity payments from lifetime income annuities are generally fixed, which makes them vulnerable to inflation. Although there are annuities available that allow for increasing payments to combat inflation.
5. Withdrawals from a rollover IRA account are variable and must meet RMD requirements, which do not track inflation. The key in a plan for retirement income, however, is that withdrawals can make up any inflation deficit. In Go2Income planning, the IRA is invested in a balanced portfolio of growth stocks and fixed income securities. While the returns will fluctuate, the long-term objective is to have a return that exceeds inflation.
6. Drawdowns from the equity in your house, which can be generated through various types of equity extraction vehicles, can be set by you either as level or increasing amounts. Use of these resources should be limited as a percentage of equity in the residence.

Key Risks That a Retirement Income Plan Should Address

A good plan for income in retirement considers the many risks we face as we age. Those include:

1. Longevity risk. To help reduce the risk of outliving your savings, Social Security, pension income and annuity payments provide guaranteed income for life and become the foundation of your plan. As one example, you should be smart about your decision on when and how to claim your Social Security benefit in order to maximize it.
2. Market risk. While occasional “corrections” in financial markets grab headlines and are cause for concern, you can manage your income plan by reducing your income’s dependence on these returns. By having a large percentage of your income safe and less dependent on current market returns, and by replanning periodically, you are pushing a significant part of the market risk (and reward) to your legacy. In other words, the kids may receive a legacy that reflects in part a down market, which can recover during their lifetimes.
3. Inflation risk. While a portion of every retiree’s income should be for their lifetime and less dependent on market returns, you need to build in an explicit margin for inflation risk on your total income. The easiest way to do that is to accept lower income at the start. For example, under a Go2Income plan, our typical investor (a female, age 70 with $2 million of savings, of which 50% is in a rollover IRA) can plan on starting income of $114,000 per year under a 1% inflation assumption. It would be reduced to $103,000 under a 2% assumption.

Source: Kiplinger, January 10, 2022.

This information is provided by LVW Advisors for general information and educational purposes based upon publicly available information from sources believed to be reliable – LVW Advisors cannot assure the accuracy or completeness of these materials.  The information presented here is not specific to any individual’s personal circumstances.  To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.  The information in these materials may change at any time and without notice.  Past performance is not a guarantee of future returns.